Value-neutral tradeoffs between failure risk and growth

Abstract

Business choices typically entail tradeoffs between potential growth rates and the risk of failure. This note applies recent results from the theoretical valuation literature to characterize, as a benchmark, the terms of that tradeoff sufficient to leave the expected value of discounted cash flows unchanged. The central result indicates that risk-neutral investors could accept sizeable increases in risk in exchange for modest improvements in expected growth rates. The benchmark result can be used to rank projects in terms of their impact on the value of the firm's equity.