Risk Adjusted Discount Rate

In Portfolio Theory and Capital Budget analysis, the rate necessary to determine the Present Value of an uncertain or risky stream of income; it is the risk-free rate (generally the return on short-term U.S. Treasury securities) plus a risk premium that is based on an analysis of the risk characteristics of the particular investment or project.

Riskless rate plus a risk premium. It is a rate adjusted upward as the investment becomes riskier. By increasing the discount rate from 10% to 15%, for example, the expected flow from the investment must be relatively larger or the increased discount rate will generate a negative NPV, and the proposed acquisition/investment will be rejected. Although difficult to apply in extreme cases, this technique has much intuitive value.