Investment project located in Indonesia and other emerging markets frequently have low systematic risk, implying that the appropriate discount rates for the projects are quite low. In practice, most firms (with some notable exceptions) use very high discount rates for these projects. One explanation that has been offered for this practice is that the investing firm uses the high discount rates in an attempt to offset the effects of optimistic cash flow estimates. Is it a good idea to adjust for the risk of overly optimistic cash flow forecasts using changes in discount rates, or should the cash flows themselves be adjusted?
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