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462 Corporate Finance BRILLIANT’S

return would be compared with the risk ñdrH¥$V H$aZo `mo½` Zht h¡Ÿ& IRR Ho$ Ho$g _|, B§Q>Z©b aoQ> H$s
adjusted rate of return. If the IRR is higher than VwbZm [añH$ ES>OoñQ>oS> aoQ> Am°\$ [aQ>Z© go H$s OmEJrŸ& `{X
RADR, the project would be acceptable, IRR, RADR go A{YH$ h¡ Vmo àmoOoŠQ> ñdrH¥${V `mo½` hmoJm,
otherwise not.
AÝ`Wm ZhtŸ&
Merits JwU
Following are the merits of risk adjusted [añH$ ES>OoñQ>oS> {S>ñH$mCÝQ> aoQ> _oWS> Ho$ JwU Bg
discount rate method: àH$ma h¡…

1. It is simple to calculate and easy to 1. BgH$s JUZm H$aZm AmgmZ VWm g_PZm gab h¡Ÿ&
understand.
2. It takes into consideration time value of 2. `h Q>mB_ d¡ë`y Am°\$ _Zr na Ü`mZ XoVr h¡Ÿ&
money.
3. It is more practical method because most 3. `h A{YH$ à¡pŠQ>H$b _oWS> h¡ Š`m|{H$ A{YH$m§e H§$n{Z`m±
of the companies apply different stand- dmñVd _| AbJ-AbJ àmoOoŠQ²>g Ho$ {bE AbJ-
ards of cost of capital for different projects AbJ H$m°ñQ> Am°\$ H¡${nQ>b H$m Cn`moJ H$aVr h¡Ÿ&
in actual practice.
Limitations NPP gr_mE±
There are some limitations of the method Bg nÕ{V H$s Hw$N> gr_mE± h¢, Omo {ZåZ{b{IV h¢…
which are as follows:
1. The principal drawback of this approach 1. Bg EàmoM H$m g~go à_wI Xmof `h h¡ {H$ {d{^Þ
is that it does not suggest how to determine àmoOoŠQ²>g go Ow‹S>r [añH$ Ho$ AbJ-AbJ bo~b Ho$
an appropriate discount rate according to AZwgma H$m¡Z-gm {S>ñH$mCÝQ> aoQ> C{MV hmoJm, Bgo
the difference in the level of risk of various
projects. Hence, it is doubtful that it will {ZYm©[aV H$aZo H$m VarH$m `h nÕ{V gOoñQ> Zht
give any objective results. H$aVr h¡Ÿ&
2. It is based on the assumption that 2. `h Bg _mÝ`Vm na AmYm[aV h¡ {H$ BÝdoñQ>g© [añH$
investors are risk-averse. Though it is boZm ng§X Zht H$aVo h¢Ÿ& gm_mÝ`V… `h R>rH$ h¡
generally true but there exists many {H$ÝVw H$B© Eogo ^r BÝdoñQ>g© h¢ Omo [añH$ boZo Ho$ ~Xbo
investors who do not demand premium àr{_`_ nmZo H$s Anojm Zht aIVo ~pëH$ [añH$ Ho$
for taking risk. Even they are willing to
pay a premium to take risk. In this ~Xbo n«r{_`_ XoZo Ho$ {bE ^r V¡`ma ahVo h¢Ÿ& Eogr
situation, the discount rate will reduce pñW{V _| [añH$ H$m bo~b ~‹T>Zo go {S>ñH$mCÝQ> aoQ>
when the level of risk increases. H$_ hmoJmŸ&
3. It does not make any risk adjustment for 3. `h Eogo H¡$e BZâbmoO Ho$ {bE H$moB© [añH$ ES>OoñQ>_|Q>
cash inflows which are also uncertain. Zht H$aVr Omo A{ZpíMV hmoVo h¢Ÿ&

3. Certainty Equivalents Approach (CEA) 3. gQ>}ZQ>r BpŠdd¡boÝQ> EàmoM (CEA)

Certainty Equivalent Approach (CEA) is gQ>}ZQ>r BpŠdd¡boÝQ> EàmoM, H¡${nbQ> ~OqQ>J go Ow‹S>r
another important method for dealing with risk hþB© [añH$ H$m {díbofU H$aZo H$s EH$ Am¡a _hËdnyU© _oWS>
in capital budgeting. Under this method, the h¡Ÿ& Bg _oWS> _| {H$gr àmoOoŠQ> go Ow‹S>r hþB© [añH$ H$mo