The Direct Determination of Risk-Adjusted Discount Rates and Liability Beta

The development of a complete financial structure including balance sheet, income and cash flow statements, coupled with conventional accounting and economic valuation rules, provides the foundation from which risk-adjusted discount rates and liability betas can be determined. Since liability betas cannot be measured directly, a shift in focus is proposed to one based on measures more readily available and better understood, such as cost of capital, equity beta, leverage, etc. The risk-adjusted discount rate is shown as a function of these variables based on the developed financial structure and valuation framework. The liability beta is then shown to follow as a con-sequence, also to be calculated as a function of these same variables. The risk-adjusted discount rates that result are less than the risk-free rate and the liability betas are negative to a greater degree than often suggested.