Project specific cost of equity

ok. Thank you. I must have misunderst. kindly explain ACCA answer to the 2008 Dec question #3c
Question: Explain how the capital asset pricing model can be used to calculate a project-specific discount rate and discuss the limitations of using the capital asset pricing model in investment appraisal.
Answer: The CAPM can be used to calculate a project-specific discount rate in circumstances where the business risk of an investment project is different from the business risk of the existing operations of the investing company. In these circumstances, it is not appropriate to use the WACC as the discount rate in investment appraisal. The first step in using the CAPM to calculate a project-specific discount rate is to find a proxy company that undertake operations whose business risk is similar to that of the proposed investment. The equity beta of the proxy company will represent both the business risk and the financial risk of the proxy company. The effect of the financial risk of the proxy company must be removed to give a proxy beta representing the business risk alone of the proposed investment. This beta is called an asset beta and the calculation that removes the effect of the financial risk of the proxy company is called ‘ungearing’. The asset beta representing the business risk of a proposed investment must be adjusted to reflect the financial risk of the investing company, a process called ‘regearing’. This process produces an equity beta that can be placed in the CAPM in order to calculate a required rate of return (a cost of equity). This can be used as the project-specific discount rate for the proposed investment if it is financed entirely by equity. If debt finance forms part of the financing for the proposed investment, a project-specific weighted average cost of capital can be calculated. The limitations of using the CAPM in investment appraisal: difficulties associated with finding the information needed (this applies to the equity risk premium, the risk-free rate of return, locating appropriate proxy companies with business operations similar to the proposed investment project); Most companies have a range of business operations they undertake and so their equity betas do not reflect only the desired level and type of business risk; the assumptions underlying the CAPM can be criticised as unrealistic in the real world. For example, the CAPM assumes a perfect capital market, when in reality capital markets are only semi-strong form efficient at best. The CAPM assumes that all investors have diversified portfolios, so that rewards are only required for accepting systematic risk, when in fact this may not be true. There is no practical replacement for the CAPM at the present time, however.

ok thanks.