Using the firms hurdle rate for individual projects

Can we use the costs of equity and capital that we have estimated for the firms for these projects? In some cases we can, but only if all investments made by a firm are similar in terms of their risk exposure. As a firm's investments become more diverse, in terms of their risk exposure, the firm is less able to use its cost of equity and capital to evaluate these projects. Projects that are riskier have to be assessed using a higher cost of equity and capital than projects that are safer. In this chapter, we consider how to estimate project costs of equity and capital.

What would happen if a firm chose to use its cost of equity and capital to evaluate all projects? This firm would find itself over investing in risky projects and under investing in safe projects. Over time, the firm will become riskier, as its safer businesses find themselves unable to compete with riskier businesses.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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