Projects with Different Risk Profiles

As a purist, you could argue that each project's risk profile is, in fact, unique, and that it is inappropriate to use either the firm's cost of equity or divisional costs of equity to assess projects. While this may be true, we have to consider the trade off. Given that small differences in the cost of equity should not make a significant difference in our investment decisions, we have to consider whether the added benefits of analyzing each project individually exceed the costs of doing so.

When would it make sense to assess a project's risk individually? If a project is large in terms of investment needs, relative to the firm assessing it, and has a very different risk profile from other investments in the firm, it would make sense to assess the cost of equity for the project independently. The only practical way of estimating betas and costs of equity for individual projects is the bottom-up beta approach.

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