The appropriate
risk adjusted discount rate has declined from the original 20 percent to 15.60 percent, which is applied to the remaining periods four through seven, indicating a current value of$15,232,318 ($15,200,000 rounded).
The second approach, adjusting risk in the discount rate as well, is the method of the
Risk Adjusted Discount Rate Approach (RADRA).
Of the approaches for adjusting for risk in discounted cash flow valuation, the most common one is the risk adjusted discount rate approach, where we use higher discount rates to discount expected cash flows when valuing riskier assets, and lower discount rates when valuing safer assets.
= (1 + Risk adjusted discount rate)/(1 + Risk-free rate) - 1
2.3.5 Risk adjusted discount rate or certainty equivalent cash flow
(13) A more common approximation used by many analysts is the difference between the risk adjusted discount rate and the risk-free rate.
Although any theoretically defensible
risk adjusted discount rate (RADR) could be used, the model is usually applied using the CAPM: [R.sub.L] = [R.sub.f] + [beta.sub.L][[R.sub.m] - [R.sub.f]], where [beta.sub.L] has the obvious definition [see Myers and Cohn (1987)].