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Unformatted text preview: ion between a project's return and its risk. However, since the company is itself a portfolio of projects and it is typically assumed that owners hold diversified portfolios, the relevant risk of a project is not its stand-along risk, but rather how it affects the risk of owners' portfolios, its market risk. Risk is typically figured into our decision-making by using a cost of capital that reflects the project's risk. The relevant risk for the evaluation of a project is the project's market risk, which is also referred to as the asset beta. This risk can be estimated by looking at the market risk of companies in a single line of business similar to that of the project, a pure-play. An alternative to finding a pure-play is to classify projects according to the type of project (e.g. expansion) and assign costs of capital to each project type according to subjective judgment of risk. Most companies adjust for risk in their assessment of the attractiveness of projects. However, this adjustment is typically done by evaluating risk subjectively and ad hoc adjustments to the company's cost of capital to arrive at a cost of capital for a particular project. 7. Solutions to Try it! Asset betas Company 3M Amazon.com Sprint Nextel Walt Disney Company Yahoo! βequity 0.90 1.70 1.15 1.35 1.90 Debt/equity 0.18609 0.21323 0.69893 0.56616 0.04413 ⎡ ⎢ ⎢ ⎢ ⎢ ⎣ (( 1 1 + (1 − τ) debt equity 0.89209 0.87827 0.68761 0.73099 0.97212 )) ⎤ ⎥ ⎥ ⎥ ⎥ ⎦ βasset 0.80288 1.49306 0.79076 0.98684 1.84702 © 2007 Pamela Peterson Drake Capital budgeting & risk, a reading prepared by Pamela Peterson Drake 14...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at University of Arizona- Tucson.

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