Risk-Adjusted Discount Rates and Capital Budgeting Under Uncertainty

This paper is concerned with the valuation of multiperiod cash flows ina world where prices are determined according to the Sharpe-Lintner-Black model of capital market equilibrium. We find that the current market value of any future net cash flow is the current expected value of the flow discounted at risk-adjused discount rates for each of the periods until the flow is realized. The discount rates are known and non-stochastic, but the rates for the different periods preceeding the realization of a cash flow need not be the same, and the rates relevant for a given period can differ across cash flows. The risk adjustments in the discount rates arise because of uncertainties about reassessments through time of the expected value of a flow and the relationships between these reassessments and the corresponding reassessments of the expected cash flows of all firms.