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A typical investment/project has both a diversifiable and non-diversifiable risk. What do diversifiable and non-diversifiablemean in...

A typical investment/project has both a diversifiable and non-diversifiable risk. What do diversifiable and non-diversifiablemean in this context? How should diversifiable risks be accounted for in project valuation? What are the benefits of this?

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Answer #1

A diversifiable risk in a project consists of risks which are specific to the project or the industry in which the project is based on. Undiversifiable risks on the other hand are risks which can not be reduced by taking on projects from non-related industries and affect entire economy.
A high level of project or industry specific risks implies that the risk adjusted return from the project should be high enough to compensate the investor for the risk undertaken by the investor.

The benefits are that it ensures a transparent and objective evluation of projects and associated risks. Thus capital allocation process becomes more efficient.

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