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    Explanation of appropriate risk adjusted discount rate

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    A company is evaluating two systems. The company's revenue stream will not be affected by the choice of the systems, the projects are being evaluated by finding the PV of each set of costs. The company's required rate of return is 13% and it adds or subtracts 3 percentage points to adjust for project risk differences. System A is judged to be a high-risk project (it might end up costing much more to operate than is expected. The appropriate risk-adjusted discount rate that should be used to evaluate System A is?

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    Solution Preview

    This issue deals with capital budgeting.

    At least five phases of capital expenditure planning and control can be identified:
    Identification (or origination) of investment opportunities.
    Development of forecasts of benefits and costs.
    Evaluation of the net benefits.
    Authorization for progressing and spending capital expenditure.
    Control of capital projects.

    In practice, however, companies, although tending to shift to the formal methods of evaluation, give considerable importance to qualitative factors.
    Some companies also consider intuition, security and social considerations as important qualitative ...

    Solution Summary

    This explains the concept of appropriate risk adjusted discount rate and its application in capital budgeting.