Risk-Adjusted Discount Rate Calculator

Risk Adjusted Discount Rate

A rate used to discount returns of high risk investments is termed risk-adjusted discount rate. This rate is used to calculate the net present value of the risky investment. The risk-adjusted discount rate calculator is an online aid in such calculation. It signifies that even though the chances of losses are higher in an investment being a high risk investment, it tends to earn a higher return.

The risk-adjusted discount rate is more appropriate for risk-averse investors who are willing to invest in a project with high risk.

Formula

The formula for calculating Risk-Adjusted Discount Rate is:

Risk-Adjusted Discount Rate = Risk-free Rate of Interest + Risk Premium

About the Risk-Adjusted Discount Rate Calculator

This calculator will provide the instant result on entering the following figures into it.

  • Risk-free rate of interest
  • Risk premium
risk adjusted discount rate calculator

Calculator

How to Calculate Using Calculator

The user simply has to insert the following data into the calculator for a quick result:

Risk-free Rate of Interest

It is the rate of interest received on investments with zero risks. Some example of risk-free investments includes treasury bills, fixed deposits, etc.

Risk Premium

The formula to calculate Risk premium (under CAPM) is:

Risk Premium = (Market Rate of Return – Risk-free Rate)*Beta

Beta is a unit to measure the risk. To know more about beta, you can refer to the following articles:

Example of Risk-Adjusted Discount Rate

Suppose a Company Micro Ltd. wants to invest in a project out of 4 options available with it. And, therefore, it is evaluating all the four options from the following details, that is, risk premium, expected cash flows, initial investments, and risk-free rate.

ParticularsProject AProject BProject CProject D
Risk Premium5%4%7%3%
Cash Flow of Y15,0008,0004,0004,000
Cash Flow of Y22,0003,00010,0007,000
Cash Flow of Y33,00010,25017,00011,000
Initial Investment7,50020,00020,25017,000

Risk free rate of return is 2%

Now Risk Adjusted Discount Rate is:

Project A = 2% + 5% = 7%

Risk-adjusted discount rate of Project B = 2% + 4% = 6%

and, Project C = 2% + 7% = 9%

Project D = 2% + 3% = 5%

Expected Net Present Values of four projects:

(Present Value of Cash Flows less Initial Investments)

Project A = 8,868.67 – 7,500 = 1,368.67

NPV of Project B = 18,823.26 – 20,000 = -1,176.74

and, Project C = 25,213.64 – 20,250 = 4,963.64

Project D = 19,660.94 – 17,000 = 2,660.94

In the example above, Project C has the highest risk-adjusted discount rate among all the four projects and also the highest NPV.

Cautions

It is true to some extent that the risk-adjusted discount rate signifies that even though the chances of losses are higher in an investment being a high-risk investment, it tends to earn a higher return. But, the calculation of the risk-adjusted discount rate is a bit complex method. Here, it is also assumed that all the investors are risk-averse but the same is not true.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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