Why would the managers of a firm take a foreign project with a lower domestic currency NPV and a higher return variance rather than a foreign project with a higher domestic currency NPV but a lower return variance?

What will be an ideal response?

This is an example of the asset substitution issue that we covered in Chapter 16 . Because shareholders only gain in good states of the world, they like the variance of the firm to be high. When the variance of the firm is higher, the shareholders gain more in the good states of the world. The bondholders get paid their full amount in good states of the world, and they get the value of the firm in the bad states of the world. By accepting a high variance project, managers may be able to shift some value from bondholders to shareholders in an asset substitution.