Investment decisions require evaluation of cash flows produced by the proposed projects using appropriate, risk-adjusted discount rates. This takes us to one of the most common and important applications of the CAPM. Chapter 9 describes this application and explains how to estimate the required rate of return or discount rate for projects using the CAPM. It is important to remember that the required rate of return on a project is a function of the risk of the project and does not depend on whom or which company undertakes it. The relevant risk of the project is, of course, its market risk or beta and not the total risk. A company’s stock beta and its cost of capital reflect the nature of all its assets as well as the financial leverage or the debt it carries in its balance sheet. Using the company cost of capital as the discount rate for all its new projects would be a serious error. We would still want to know what return is expected from the securities of a company and the cost of capital for the company as a whole, because this provides us with a benchmark return. From this, we can work out what return is required from projects whose risks are similar to those of the company's existing business. Riskier projects should have a higher hurdle rate and safer projects a lower cutoff rate.

The chapter describes how one can estimate betas for companies using market information. We can estimate the beta of a stock by comparing the stock’s returns over time against the market returns. Individual company beta estimates tend to be unstable and it is often better to calculate the beta for the industry group to which the company belongs. The chapter also has a detailed discussion of the relationship between beta, financial leverage, and operating leverage.

Other related topics covered in the chapter include the risk and betas for foreign projects, basic determinants of beta, and the common, but often erroneous, practice of using arbitrary risk premiums (fudge factors) to adjust for projects considered risky. The concept of certainty equivalent, an alternate approach to adjust for the risk of cash flows, is also explained in this chapter.

Most of the discussions on risk-adjusted returns in the chapter use the CAPM as the theoretical risk-return model. The basic principles covered apply to other models like the APT or the three-factor model as well.