Challenges in advanced management accounting
Challenges in advanced management accounting

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3.7.2 Problems with financial risk

Using the average beta from the relevant industry for a project does not eliminate the problem of financial risk mentioned earlier. What this means in practice, is that the equity risk of the company that has the project and the comparison industry will vary depending on how much debt they also carry (i.e. if there is a difference in their capital structures).

As discussed earlier, when comparing the company’s project with the company as a whole, there will be a difference in financial risk if the company’s project is funded with a different capital structure from the company as a whole. (In the activities above, it has been assumed that the company and its project are entirely funded by equity capital.) However, even if the same capital structure is used, there can also be differences between the company considering a project and the comparison industry whose beta is used to evaluate the project. If that industry has a different capital structure on average from the company considering the project, then the comparison industry will vary in financial risk from the project being considered, and this will systematically affect the beta used by the comparison industry.

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