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Risk Adjusted Discount Rates and the Present Value of Risky Costs

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  • Ariel, Robert

Abstract

In capital budgeting the correct risk adjusted discount rate for future cash flows is independent of whether the flow is a cost or a revenue. Contrary to a widely disseminated view in some popular textbooks and elsewhere, costs are not especially safe (nor risky), and accordingly costs should not be discounted at especially low risk adjusted discount rates. This paper analyzes capital budgeting within a portfolio model in which revenues and costs appear as "long" and "short" portfolio positions, respectively, and proves that costs are neither more nor less intrinsically risky than revenues. Copyright 1998 by MIT Press.

Suggested Citation

  • Ariel, Robert, 1998. "Risk Adjusted Discount Rates and the Present Value of Risky Costs," The Financial Review, Eastern Finance Association, vol. 33(1), pages 17-30, February.
    • Handle: RePEc:bla:finrev:v:33:y:1998:i:1:p:17-30
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    Cited by:

    1. Meitner, Matthias, 2003. "Option-Style Multi-Factor Comparable Company Valuation for Practical Use," ZEW Discussion Papers 03-76, ZEW - Leibniz Centre for European Economic Research.
    2. Hoi Wong, 2000. "Capital rationing: The general case and a better criterion for ranking," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 24(1), pages 90-96, March.
    3. Rajaratnam, Myuran & Rajaratnam, Bala & Rajaratnam, Kanshukan, 2014. "A novel equity valuation and capital allocation model for use by long-term value-investors," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 483-494.

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