Question

what is risk adjusted discount rate? how is it used?

Answer #1

Broadly,

Discount rate = Minimum expected rate + Risk premium

Risk adjusted discount rate is rate which is provided with risk premium or loaded with risk premium. The risk premium is a rate which take cares for risk which is taken for a given project.

Each project carries different proportionate of risk and such projects are discounted with higher discount rate to compensate investors.

Investor taking up risky project will demand for higher risk premiums hence discount rate for such project will be higher.

Investor taking up less risk project will earn lower discount rate in comparison to one who takes up risk project.

Discount rates are used to discount the future cash flow of the project. Higher the discount rate will impact the present values of the project. This higher rate of discounting is nothing but the risk adjustment.

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If let me know in comment if more explanation needed.

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