Introduction to Finance

risk-adjusted discount rate (RADR) 
adjusts the required rate of return 
at which the analyst discounts a 
project’s cash fl ows based on the 
project’s risk
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Another, more complicated, technique is to use the capital asset pricing model (CAPM). A beta is calculated for 
each project based on analysis of fi rms in lines of business similar to that of the proposed project. The security market 
line (SML) is used with the beta estimate to approximate the project’s required return.
TA B L E 1 7 . 8
Risk Categories, RMEN Corporation
Below-average risk:
Replacement decisions that require no change, or only a minor change, in technology; no change 
in plant layout required
Discount rate = Cost of capital – 2%
Average risk:
Replacement decisions involving significant changes in technology or plant layout; all cost-saving 
decisions; expansions and improvements in the firm’s main product lines
Discount rate = Cost of capital
Above-average risk:
Applied research and development; introduction of new products not related to major product 
lines; expansion of production or marketing efforts into developed economies in Europe and Asia
Discount rate = Cost of capital + 2%
High risk:
Expansion of production or marketing efforts into less-developed and emerging economies; 
introduction of products not related to any of the firm’s current product lines
Discount rate = Cost of capital + 5%

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Summary
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fi nancial manager. This would result in an NPV of –$514. Thus, on a risk-adjusted basis, pro-
ject A would still be acceptable to the fi rm, but project B would be rejected. Making adjust-
ments for risk diff erences is a diffi
cult but necessary task if the fi nancial manager is to make 
capital budgeting decisions that will increase the fi rm’s value.