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460 Corporate Finance BRILLIANT’S

project will go exactly as planned for a certain O¡go `moOZm ~ZmB© JB© h¡ Am¡a CgHo$ níMmV² AMmZH$ g_mßV
period and then it will suddenly cease and be hmo OmVr h¡Ÿ& Bg àH$ma, {H$gr àmoOoŠQ> Ho$ EH$ {ZpíMV
worth nothing. The risk that a project will Ad{Y Ho$ ~mX AMmZH$ ~§X hmoZo H$s [añH$ V^r CËnÝZ
suddenly cease altogether after a certain period hmoVr h¡ O~ `wÕ àma§^ hmo OmE, dH©$am| H$s A{ZpíMVH$mbrZ
may arise due to reasons such as civil war in h‹S>Vmb Ho$ H$maU {~OZog ~§X hmo OmE AWdm {H$gr
country, closure of business due to an indefinite H$ånr{Q>Q>a Ûmam Z`m àmoS>ŠQ> _mH}$Q> _| bmH$a nyao _mH}$Q>
strike by the workers or introduction of a new
H$mo H¡$ßMa H$a {b`m OmEŸ& {ZpíMV hr Bg àH$ma H$s [añH$
product by a competitor which captures the
hmoVr h¡ {H$ÝVw CZH$m AZwnmV gm_mÝ` ì`mdgm{`H$ [añH$
whole market etc. No doubt, such risk exists O¡go {dH«$` KQ>Zm `m H$m°ñQ> ~‹T>Zm Am{X H$s VwbZm _| H$_
but they do not constitute a large proportion
of common business risks like lower sales, hmoVm h¡Ÿ& gmW hr `h H¡$e âbmo H$s Q>mB©_ d¡ë`y na Ü`mZ
Zht XoVm h¡Ÿ& CXmhaU Ho$ {bE, Xmo àmoOoŠQ²>g H$m no-~¡H$
higher costs etc. Secondly it ignores the time
value of cash flows. For example, two projects nr[a`S> g_mZ (CXmhaU Ho$ {bE, Mma df©) h¡ {H$ÝVw CZHo$
with, say a four-year payback period are at gmW Ow‹S>r hþB© [añH$ {~ëHw$b AbJ-AbJ hmo gH$Vr h¡
very different risks if in one case the capital is `{X nhbo àmoOoŠQ> H$s H¡${nQ>b Mma dfm] _| Mma g_mZ ^mJm|
recovered evenly over the four years, while in _| [aH$da hmo O~{H$ Xygao àmoOoŠQ> H$s nyar H¡${nQ>b A§{V_
the other it is recovered in the last year. df© _| [aH$da hmo& {ZpíMV hr Xygam àmoOoŠQ> A{YH$ [añH$s
Obviously, the second project is more risky. If h¡Ÿ& `{X XmoZm| àmoOoŠQ> VrZ dfm] Ho$ ~mX AMmZH$ ~§X hmo OmE
both cease after three years, the first project Vmo nhbo àmoOoŠQ> H$s VrZ-Mm¡WmB© H¡${nQ>b [aH$da hmo MwH$s
would have recovered three-fourths of its hmoJr O~{H$ Xygao àmoOoŠQ> H$s nyar H¡${nQ>b g_mßV hmo
capital, while all capital would be lost in the OmEJrŸ& A{ZpíMVVm H$mo Ü`mZ _| aIVo hþE g§^d h¡ {H$
case of second project. Given the uncertainty
Mma df© no-~¡H$ nr[a`S> dmbm àmoOoŠQ> `{X {ZpíMV Ad{Y
element, it may be that a four-year payback dmbm hmo Vmo {H$gr Xygao Eogo àmoOoŠQ> go ~ohVa h¡ {OgH$m
period based on fairly certain estimates might
no-~¡H$ nr[a`S> ^bo hr VrZ df© hmo {H$ÝVw Omo A{ZpíMVVmAm|
be preferred to a three-year payback period,
calculated with very uncertain estimates. na AmYm[aV hmoŸ&

2. Risk Adjusted Discount Rate (RADR) 2. [añH$ ES>OoñQ> {S>ñH$mCÝQ> aoQ> (RADR)
For a long time, it is assumed that the busi- àma§^ go hr `h _mZm OmVm h¡ {H$ {~OZog_¡Z BÝdoñQ>_oÝQ>
ness man required additional return over and H$aHo$ Omo [añH$ boVm h¡ Cg na Cgo [añH$ \«$s aoQ> Am°\$ [aQ>Z©
above the risk free rate of return for the risk
which he takes in investment. If the risk is higher, H$s VwbZm _| Hw$N> A{V[aº$ [aQ>Z© {_bZm Mm{hEŸ& `{X [añH$
the required premium should also be higher. On A{YH$ h¡ Vmo Ano{jV àr{_`_ ^r A{YH$ hmoJmŸ& Bg H°$ZgoßQ>
the basis of this concept, it is proposed that the
Ho$ AmYma na `h _mZm J`m {H$ H¡${nQ>b ~OqQ>J {díbofU _|
risk premium may be incorporated into the capi-
tal budgeting analysis through the discount {S>ñH$mCÝQ> aoQ> H$s ghm`Vm go [añH$ àr{_`_ H$mo gpå_{bV
rate. The time preference for money can be rec- {H$`m Om gH$Vm h¡Ÿ& _Zr Ho$ Q>mB©_ {à\$aoÝg Ho$ {bE [añH$ \«$s
ognized by risk free rate and the risk preference aoQ> Am°\$ [aQ>Z© boH$a Cg_| [añH$ {à\$aoÝg Ho$ {bE [añH$
should be associated with risk premium rate
àr{_`_ aoQ> Omo‹S>m Om gH$Vm h¡Ÿ& XmoZm| H$mo {_bmH$a àmßV aoQ>
which may be added to risk free rate. Such com-
posite rate is called Risk Adjusted Discount Rate. H$mo [añH$ ES>OoñQ>oS> {S>ñH$mCÝQ> aoQ> H$hm OmVm h¡Ÿ&