Project valuation is a notoriously imprecise art. “Two of the ubiquitous tools in capital budgeting are a wing and a prayer,” economists Eugene Fama and Kenneth French once famously observed. But by using a new method for calculating the cost of equity capital, financial managers can put valuation decisions on more solid ground.That's the central claim of a June 2001 article in the Journal of Accounting Research. As co-author Charles M.C. Lee explains, many common methods for calculating the cost of equity, including the venerable capital-asset-pricing model (CAPM), share a significant flaw. The underlying theory focuses on expected returns, an imprecise measure. CAPM, for example, predicts the cost of equity as a function of beta — the relationship between the return that investors expect from a company and the return they expect from the market as a whole.To gauge expected returns, companies typically rely on historical or realized returns. In principle, that shouldn't matter. If markets are efficient, realized returns over a sufficiently long period should approximate expected returns. But in practice, realized returns turn out to be “a pretty lousy proxy,” Lee says.