One-size Risk-Adjusted Discount Rate does not fit all risky projects

The Risk-Adjusted Discount Rate (RADR)-method is one of the most popular procedures used in the managerial context to incorporate downside risk into capital budgeting modelling. The RADR-method consists of discounting the project stream of future inflows at the Risk-Adjusted Discount Rate (RADR), a rate that is usually higher than the firm's corporate cost of capital. We show that the Modified Duration, a volatility measure used in the fixed income market, that summarizes in a single number the bi-dimensional information about the inflows and terms in which they are charged, gives a primary key in the NPV reduction. An alternative method used in academia is the Expected net Present Value (EPV) method. Through decision-makers’ assessments on the potential losses and their probability of occurrence, we identify the proper RADR that leads the same NPV risk-adjustments, whichever method is used. Our results are useful to provide decision-makers a better awareness as to how to select the proper RADR by reducing the subjectivity and increasing financial precision based on Modified Duration, thus providing an alternative to the norm.