The main parameter under consideration while designing for any project is to minimize the associated risk factors to its full extent. With more clarity, it can be said that a project is so adjusted to reflect the maximum risk cost. The real fact behind this thought is that such an assignment has to meet higher hurdles than the related low-risk ones.
Basically, there are two methods to encounter the risk associated with a venture plan
Elevating the rate of discount:
For creating a foundation with the risk-free parameter, a premium rate is to be added to the assignment. This idea can be aggregated into a single term known as the discount rate. The premium value to be paid is in direct proportion to the risk-rate involved. That means, higher the risk, higher also will be the premium cost. Moreover, it is better to have a stronger base than that needs a number of restructuring the future resulting in greater expense.
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Let us consider the example of this particular case. Suppose a business builder offers a future payment of $200,000 within two years of signing the consent. If this payment occurs for sure, then the present value of this future cash would be calculated with an interest rate of 4%. But if in any case, the payment is uncertain, an extra or an appropriate risk premium of 3% should be added, giving a total interest rate of 7% and should be definitely approved. Thus, future payments need a higher discounted rate.
The exact size or the quantity of a business associated risk premium calculation is entirely dependent on the practice of how much an investor demand in extra so as to hold the project securities in an appropriate market.
Lowering the awaited payment:
This is an alternative way to the above mentioned. The method adopted here is the reduced flow of cash by adjusting the risk factor. Take for example; suppose a project owner will pay $300,000 in five years. The real amount of payment would be higher or lower than this value after considering or avoiding the risky agents. If he assures giving a payment of $280,000, then this is the matching to the risky $300,000. So better calculate the surety amount using the risk-free interest rate.
It is simple and easy to calculate or determine the apt risk-tuned payment value if we know the exact risk amount and our personal rate of risk.