Multiple Businesses with Different Risk Profiles Project Risk similar within each Business

When firms operate in more than one line of business, the risk profiles are likely to be different across different businesses. If we make the assumption that projects taken within each business have the same risk profile, we can estimate the cost of equity for each business separately and use that cost of equity for all projects within that business. Riskier businesses will have higher costs of equity than safer businesses, and projects taken by riskier businesses will have to cover these higher costs. Imposing the firm's cost of equity on all projects in all businesses will lead to over investing in risky businesses (since the cost of equity will be set too low) and under investing in safe businesses (since the cost of equity will be set too high).

How do we estimate the cost of equity for individual businesses? When the approach requires equity betas, we cannot fall back on the conventional regression approach (in the CAPM) or factor analysis (in the APM), since these approaches require past prices. Instead, we have to use one of the two approaches that we described in the last section as alternatives to regression betas - bottom-up betas based upon other publicly traded firms in the same business or accounting betas, estimated based upon the accounting earnings for the division.

Retirement Planning For The Golden Years

Retirement Planning For The Golden Years

If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.

Get My Free Ebook

Post a comment