In [[Entrepreneurial Finance]] the Risk Adjusted Discount Rate or RADR is defined as a common method of estimating [[Present Value]]. The second common method is called the [[Certainty Equivalent Cash Flow]] method. In the RADR method an expected future cash flow is convert to [[Present Value]] by applying a discount rate that represents both:
* The [[Time value of money]]
* The ''//riskiness//'' of the future cash flow

For a particular project $\Large j$, that yields and uncertain cash flow at time $\Large t$ the appropriate discount rate for valuing the expected cash flow can be stated as follows:

$\Large r_{jt}$ $\Large =$ $\Large r_{Ft} + RP_{jt}$

Where:
$\Large r_{Ft}$ is the required rate of return (or cost of capital, see [[WACC]]) and
$\Large RP{jt}$ is the risk adjustment to the discount rate.

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.

The present value by the risk adjusted discount rate method is given as:
$\Large {PV_j} = \sum_t{\frac{C_jt}{(1+r_t)^t}}$
bag
finance_public
created
Thu, 05 Jan 2012 21:01:51 GMT
creator
dirkjan
modified
Thu, 05 Jan 2012 21:01:51 GMT
modifier
dirkjan
tags
Entrepreneurial Finance
M13
Term
creator
dirkjan