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Dear sir,
I summarized the risk-adjusted discount rate and CAPM as:
We incorporate the risk of an investment by discounting the cash flows at higher rate called risk-adjusted discount rate.
Risk adjusted discount rate is calculated by using the CAPM formula, which considers only the systematic risk of the investment. We do not incorporate the unsystematic risk in F9 and P4.
In F9, we assume that the company is all equity-financed. Therefore we use the CAPM formula to calculate the project specific cost of equity.
In P4, we will consider both equity and debt financing of a company. Therefore we will use the CAPM formula to calculate the WACC.
Please correct me if I am wrong anywhere. Thanks,
Your first three paragraphs are correct.
However in F9 we do not assume that the project is all equity-financed. The project specific cost of equity is the determined by the risk of the equity which is due to the business risk of the project and the gearing in the project. Therefore we need the asset beta which we then use to calculate the equity beta which is what determines the cost of equity for the project.
In P4 we use the CAPM formula to get the cost of equity and this cost of equity is used in the WACC calculation (just as is the case in F9). However if the gearing is changing a lot when doing the new project we calculate the APV instead of discounting at the WACC.
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