Assessing Project Risk

Détails

ID Serval
serval:BIB_0C0B3AD2C668
Type
Article: article d'un périodique ou d'un magazine.
Collection
Publications
Institution
Titre
Assessing Project Risk
Périodique
Journal of Applied Corporate Finance
Auteur⸱e⸱s
Bernardo  A., Chowdhry  B., Goyal  A.
ISSN
1078-1196
Statut éditorial
Publié
Date de publication
09/2012
Peer-reviewed
Oui
Volume
24
Numéro
3
Pages
94-100
Langue
anglais
Résumé
Finding the appropriate discount rate, or cost of capital, for evaluating investment projects requires an accurate estimate of project risk. This can be challenging because project risk cannot be estimated directly using the CAPM, but must instead be inferred from a set of traded securities, typically the equity betas of comparable firms in the same industry. These equity betas are then unlevered to undo the effect of comparable companies' financial leverage and obtain estimates of "asset" betas, which are then used to estimate project risk.
The authors show that asset betas estimated in this way are likely to overestimate project risk. The equity returns of companies are risky not only because of their existing projects but also because of their growth opportunities. Such growth opportunities often include embedded "real options," such as the option to delay, expand, or abandon a project. Because such real options are similar to leveraged positions in the underlying project, a company's growth opportunities are typically riskier than its existing projects. Therefore, to properly assess project risk, analysts must also unlever the asset betas derived from comparable company stock returns for the leverage contributed by their growth options.
The authors derive a simple method for unlevering asset betas for growth options leverage in order to properly assess project risk. They then show that standard methods for assessing project risk significantly overestimate project costs of capital-by as much as 2-3% in industries such as healthcare, pharmaceuticals, communications, medical equipment, and entertainment. Their method should also be applied to stock return volatility to derive project volatility, an important input for determining the value of a firm's growth opportunities and the appropriate time for investing in these opportunities.
Création de la notice
15/03/2014 17:17
Dernière modification de la notice
21/08/2019 5:12
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