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101 Concepts for the Level I Exam

Concept 62: Beta of a Project

Project’s beta is a measure of systematic or market risk present in a particular project. It is used to adjust for differences between project’s risk and firm’s average risk.

Project’s beta is estimated using ‘Pure play method’. This method has three steps:

Step 1: Shortlist comparable publicly traded companies.

Step 2: Derive unlevered beta or comparable asset beta for the project using comparable company’s D/E and tax rate:

     $${{\beta }_{asset}=\beta }_{equity}*{{1}\over {1+{{\left(1-t\right)D}\over {E}}}}$$

Step3: Get the equity levered beta for the project using project specific D/E and tax rate:

     $${\beta }_{equity}=\ {\beta }_{asset}*\left(1+{{\left(1-t\right)D}\over {E}}\right)$$

Drawbacks of “Pure Play” method:

  • Public companies’ betas are dependent on time frequency and indexes used.
  • Beta obtained in step 3 may need to be adjusted upwards for small firms.

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