The sum of its parts

One can view a corporation’s individual projects as a portfolio of options – useful risk management tools to be used if their risk/return ratios are better than that of the firm as a whole. But how to work out the equity cost of capital at this disaggregated level? Rebecca Leiter and Tom Madden suggest some simulation techniques to develop an equity cost of capital for these corporate subunits

It is well known that the weighted average cost of capital for corporate subdivisions or individual projects is likely to be different from the cost of capital for the consolidated corporation. If we view the corporation as a portfolio of assets that are, in effect, real options that can be exercised if the return on an asset is greater than the corporation’s market return, the composition of this asset portfolio is clearly a major driver of the firm’s profitability. Not every project should