Assessing Project Risk

9 Pages Posted: 13 Oct 2012

See all articles by Antonio E. Bernardo

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area

Bhagwan Chowdhry

UCLA Anderson; Indian School of Business

Amit Goyal

University of Lausanne; Swiss Finance Institute

Date Written: Summer 2012


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.

Suggested Citation

Bernardo, Antonio E. and Chowdhry, Bhagwan and Goyal, Amit, Assessing Project Risk (Summer 2012). Journal of Applied Corporate Finance, Vol. 24, Issue 3, pp. 94-100, 2012, Available at SSRN: or

Antonio E. Bernardo (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2198 (Phone)
310-206-5455 (Fax)

Bhagwan Chowdhry

UCLA Anderson ( email )

Los Angeles, CA 90095-1481
United States
310-825-5883 (Phone)
310-206-5455 (Fax)


Indian School of Business ( email )

Hyderabad, Gachibowli 500 032


Amit Goyal

University of Lausanne ( email )

Batiment Extranef 226
Lausanne, Vaud CH-1015
+41 21 692 3676 (Phone)
+41 21 692 3435 (Fax)


Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

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