When a company is evaluating an investment with discounted cash flows, if the investment has a higher risk, the company will use a lower discount rate, and vice versa.

Question

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When an investment has a higher risk, the company will use a higher discount rate to account for the increased risk. This is because a higher discount rate means that future cash flows are worth less in today's dollars, so the company needs to discount them more heavily to account for the increased uncertainty. Conversely, a lower risk investment would have a lower discount rate applied to it.

When a Company Is Evaluating an Investment with Discounted Cash