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.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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