The first part of the book has been concerned with the expected return on capital regarded as a financial asset, in the setting of a theoretical capital market. There is a shift in perspective at this point, from the pure theory of what determines the expected returns on assets in an artificial world, to more applied theory regarding the use and determination of discount rates in project valuation. The contingent-states abstraction provides a rich environment for analysis, which yields theories of how the expected returns on assets are determined. But it cannot be used directly for the purpose of estimating the cost of capital of a real project. The analyst could perhaps think of a project as providing different pay-offs in different future states, but he would have no means of estimating the state prices of the postulated states (the prices of elementary contingent claims). We need a way of thinking about discount rates that connects both with the theory of expected returns and with what is feasible in terms of estimation, of a project's cash flows and of expected returns on other assets. We are concerned now with the determination of the cost of capital of a particular project, not with the analysis of equilibrium, so the expected returns on existing assets are taken as given.

The main bridge between the world of theory and the real world has, to date, been the standard CAPM. The reason, presumably, is that the model offers the best available combination of theoretical grounding and ease of use in practice.