Question

If a firm becomes more risky (for instance, more volatile stock price), then we might initially think that firm value would decline, because the present value of future cash flows decreases with a higher discount rate. However, empirical evidence suggests the opposite for young, small and R&D intensive firms (firm value tends to increase with increased volatility).

Answer 1

Value of young and small firms tend to increase with increased volatility because there is a growth rate which is associated with these young and vibrant firms which are related with work, which are research and development incentive so once any of the project get successful there would be huge value in place, so the volatility associated with this firm are waiting on some dramatic turnaround related to the research and development initiative of these young forms.

Volatility does not always mean that it is bad as volatility is the the increase in uncertainty due to several factors and those factors may be positive in nature for many firms, if the market is discounting positive uncertainty in respect of these young firms they will grow into value .