Capital budgeting methods require estimates of project
betas which, using the Capital Asset Pricing Model (CAPM),
allow us to estimate the cost of capital used for
discounting expected future cash flows. In practice,
equity betas are estimated using stock returns of
comparable firms which are then unlevered for financial
leverage to estimate asset betas. We show that asset
betas estimated in this way overestimate project risk
because they include growth options leverage. We show a
simple method for unlevering asset betas for growth
options leverage which can then be used to properly
value investment projects. A similar problem arises when
estimates of stock return volatility are used to
estimate project volatility, an important input in "real
options" models. Our method for unlevering asset betas
can be applied to stock return volatility to derive
project volatility which can then be used to properly
value real options. pdf 2012
