The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, Second Edition

Conclusion

The risk-free rate is the starting point for all expected return models. For an investment to be risk-free, it has to meet two conditions. The first is that no risk of default can be associated with its cash flows. The second is that the investment can have no reinvestment risk. Using these criteria, the appropriate risk-free rate to use to obtain expected returns should be a default-free (government) zero coupon rate that is matched up to when the cash flow or flows that are being discounted occur. In practice, however, it is usually appropriate to match up the duration of the risk-free asset to the duration of the cash flows being analyzed. In corporate finance and valuation, this will lead us toward long-term government bond rates ...