Calculating NPV with Risk Premium

[subornaakter30]

It is important to consider that the higher a person assesses the risk of an investment idea, the more serious the requirements are for its future profitability. This principle is reflected in NPV calculations, as the discount rate increases. It includes risk adjustments (risk premiums).

However, this is only one approach to accounting for risks under uncertainty. It is not universal. For example, professors Cheng Li and Joseph Finnerty note: "In some real-world situations, we japan mobile phone numbers database can indeed estimate future revenues. However, such calculations cannot be absolutely accurate.

It is therefore advisable to take into account a certain level of risk. To do this, the future positive cash flows should be discounted at the rate for certain risk-equivalent securities or investments. This allows the NPV value to be calculated for any investment, regardless of the level of risk."

However, not all experts share this opinion. For example, P. L. Vilensky, V. N. Livshits and S. A. Smolyak express a critical attitude towards this approach:

"This method is often recommended in Western financial literature. It is actively used in practice. However, it is not the only correct one. In addition, this method lacks sufficient theoretical justification."

Examples of NPV calculations
Now let's look at the first example from the table below. Pay special attention to the row "Difference in present value of net cash flows without and with risk." Each value in this row is calculated as the difference between the present value of net cash flows (without risk - PVt') and the present value of net cash flows (with risk - PVt).