The Discount Rate for Investment Analysis Applying Expected Utility

Manel Baucells () and Samuel E. Bodily ()
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Manel Baucells: Darden School of Business, University of Virginia. Charlottesville, Virginia 22906
Samuel E. Bodily: Darden School of Business, University of Virginia. Charlottesville, Virginia 22906

Decision Analysis, 2024, vol. 21, issue 2, 125-141

Abstract: In decision analysis, expected utility of discounted cash flows is the traditional approach to incorporate risk aversion into the evaluation of a project. The choice of discount rate as well as the convergence with the beta-adjusted approach from finance have always been in question. To address this gap, we adopt a risk-sharing setup in which investors have both treasuries and the stock market as alternatives to the project. For a full utility analysis of all the investor’s capital, we provide a unique discount rate that allows setting the horizon at the termination of the project. For a traditional analyst who conducts expected utility of discounted cash flows and ignores the capital not allocated to the project, we recommend an adjusted discount rate that compensates for double-counting the systematic risk.

Keywords: expected utility; net present value; discount rate; project evaluation (search for similar items in EconPapers)
Date: 2024
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