Web Appendix 12E

Web Appendix 12E - 12E-1In Chapter 8 we discussed the...

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Unformatted text preview: 12E-1In Chapter 8 we discussed the estimation of betas for stocks, and we indicated the diffi-culties encountered when estimating beta. Estimating project betas is even more difficult,and more fraught with uncertainty. However, two approaches have been used to estimateindividual assets’ betas—the pure play method and the accounting beta method.The Pure Play MethodIn the pure play method,the company finds several single-product companies in thesame line of business as the project being evaluated and then averages those companies’betas to determine the cost of capital for its own project. For example, suppose Erie (dis-cussed in Web Appendix 12D) found three existing single-product firms that operatebarges, and suppose also that Erie’s management believes its barge project would be sub-ject to the same risks as those firms. Erie could then determine the betas of those firms,average them, and use this average beta as a proxy for the barge project’s beta.1The pure play approach can only be used for major assets such as whole divisions,and even then it is frequently difficult to implement because it is often impossible to findpure-play proxy firms. However, when IBM was considering entering the personal com-puter market, it was able to obtain data on Apple Computer and several other essentiallypure-play personal computer companies. This is often the case when a firm considers apure-play personal computer companies....
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Web Appendix 12E - 12E-1In Chapter 8 we discussed the...

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