In capital budgeting, what does a risk-adjusted discount rate reflect?

A risk-adjusted discount rate is crucial in capital budgeting as it takes into account the specific risk associated with a particular project. When evaluating investment opportunities, it's important to recognize that not all projects carry the same level of risk. The risk-adjusted discount rate modifies the base discount rate – often the firm’s weighted average cost of capital – to reflect the unique risks tied to the expected cash flows of the project in question.

By incorporating the project's specific risk into the discount rate, decision-makers can accurately assess whether the potential returns justify the risks involved. This approach allows for a more nuanced analysis, catering to factors such as market volatility, operational risks, and other uncertainties that might affect the project's success and overall financial viability.

The other options do not capture the essential purpose of a risk-adjusted discount rate in capital budgeting. The standard cost of capital represents an average that might not be suitable for all projects, and adjustments for inflation pertain more to initial cash flow estimates rather than discount rates. The interest rate on current loans similarly does not align with the varying risk profiles of different projects. Therefore, adjusting the discount rate for specific risk leads to better investment decisions by properly aligning risk and return expectations.