Risk Adjusted Discount Rates and the Present Value of Risky Costs

Robert Ariel

The Financial Review, 1998, vol. 33, issue 1, 17-30

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.

Date: 1998
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