Risk-adjusted discount rate
A riskier stream of cash flows generally requires a higher expected return from investors who bear its relevant risk. In appraisal, discounting at an appropriate rate incorporates that required return into value. The company's existing WACC is suitable only when assumptions about business risk and financing remain appropriate. A project in a different industry may need a project-specific rate derived from comparable businesses. Raising a rate arbitrarily is not a substitute for explaining the risks, and changing both cash-flow estimates and the rate for the same risk can double-count its effect.
Worked example
An investment returns $120,000 in one year for a $100,000 initial cost. At 10%, NPV is $9,090.91. At a justified project-specific rate of 18%, NPV is $1,694.92. The higher required return reduces value; it does not change the forecast cash receipt itself.
Common mistake
Using the current company WACC for every project regardless of its business risk or financing assumptions.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |