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| − | In [[Entrepreneurial Finance|Entrepreneurial Finance]] the Risk Adjusted Discount Rate or RADR is defined as a common method of estimating [[Present Value|Present Value]]. The second common method is called the [[Certainty Equivalent Cash Flow|Certainty Equivalent Cash Flow]] method. In the RADR method an expected future cash flow is convert to [[Present Value|Present Value]] by applying a discount rate that represents both:
| + | Risk Adjusted Discount Rate |
| − | * The [[Time value of money|Time value of money]]
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| − | * The '''''riskiness''''' of the future cash flow
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| − | For a particular project <math>j</math>, that yields and uncertain cash flow at time <math>t</math> the appropriate discount rate for valuing the expected cash flow can be stated as follows:
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| − | <math>r_{jt}</math> <math>=</math> <math>r_{Ft} + RP_{jt}</math>
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| − | Where:
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| − | <math>r_{Ft}</math> is the required rate of return (or cost of capital, see [[WACC|WACC]]) and
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| − | <math>RP{jt}</math> is the risk adjustment to the discount rate.
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| − | In simple terms this can be interpreted that the future cash flows are discounted faster because there is a non-neglect able risk that the future return is lower or higher than currently expected.
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| − | The present value by the risk adjusted discount rate method is given as:
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| − | <math>{PV_j} = \sum_t{\frac{C_jt}{(1+r_t)^t}}</math>
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| | [[Category:finance]] | | [[Category:finance]] |
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Revision as of 18:39, 27 August 2020
Risk Adjusted Discount Rate
