RADR Calculator (CAPM Model)
Typically the yield on 10-year Treasury bonds.
Measure of volatility relative to the market (1.0 = market average).
The expected return of the market portfolio (e.g., S&P 500).
Additional premium for company-specific risks (size, liquidity, etc.).
Please enter valid numeric values for all fields.
Base Risk-Free Rate:
Market Risk Premium (Rm – Rf):
Beta Adjusted Premium:
Specific Risk Added:
Risk Adjusted Discount Rate:
Understanding the Risk Adjusted Discount Rate (RADR)
In financial valuation and corporate finance, the Risk Adjusted Discount Rate (RADR) is a critical metric used to determine the present value of future cash flows. Unlike a generic interest rate, the RADR specifically accounts for the risk profile of a particular investment or project.
The core principle is simple: higher risk investments require higher returns. When valuing an asset, future cash flows that are uncertain (risky) must be discounted at a higher rate than certain cash flows. This calculator uses the Capital Asset Pricing Model (CAPM) approach to derive this rate.
The Calculation Formula
The most common method to calculate the Risk Adjusted Discount Rate is by building up from the risk-free rate using the CAPM formula, plus any specific risk premiums:
RADR = Rf + β × (Rm – Rf) + Rs
- Rf (Risk-Free Rate): The theoretical return of an investment with zero risk. In practice, the yield on long-term government bonds (like the 10-year US Treasury) is used as a proxy.
- β (Beta): A measure of an asset's volatility in relation to the overall market. A beta greater than 1.0 indicates higher volatility (higher risk) than the market, while a beta less than 1.0 indicates lower volatility.
- Rm (Expected Market Return): The average return investors expect from the stock market as a whole (historically often estimated around 8-10%).
- (Rm – Rf): This is known as the Market Risk Premium. It represents the extra return investors demand for holding risky assets (stocks) over risk-free assets.
- Rs (Specific Risk Premium): Additional adjustments for risks unique to the specific company or project, such as small company size ("small cap premium"), liquidity issues, or country-specific political risk.
Why is RADR Important?
Using the correct discount rate is vital for Discounted Cash Flow (DCF) analysis and Net Present Value (NPV) calculations.
- Investment Decisions: If a project's Internal Rate of Return (IRR) is higher than its RADR, it typically creates value for shareholders.
- Valuation Accuracy: Using a generic rate for all projects can lead to disastrous capital allocation. Safe projects might be rejected (undervalued) and risky projects accepted (overvalued).
- Risk Management: It forces management to quantify the risk associated with a specific business unit or new venture, rather than relying on the company-wide Weighted Average Cost of Capital (WACC).
Example Scenario
Imagine a tech startup is evaluating a new software product.
- The 10-year Treasury yield (Risk-Free Rate) is 4.0%.
- The product is highly volatile compared to the market, with a Beta of 1.5.
- The expected return of the S&P 500 is 10.0%.
- Due to the small size of the team, analysts add a Specific Risk Premium of 2.0%.
Calculation:
4.0% + 1.5 × (10.0% – 4.0%) + 2.0%
= 4.0% + 1.5 × (6.0%) + 2.0%
= 4.0% + 9.0% + 2.0%
= 15.0%
Any cash flows from this new software product should be discounted at 15.0% to determine their fair present value.