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Picking the Risk-Free Rate

The risk-free rate is the bedrock of every DCF model. It is the return you can earn on a truly safe investment — in practice, U.S. Treasury securities, which carry no default risk because they are backed by the full faith and credit of the U.S. government. The risk-free rate anchors both the cost of equity and the cost of debt, feeding directly into WACC. Picking the wrong one distorts your entire valuation.

Quick definition​

The risk-free rate is the yield on a government bond (typically U.S. Treasuries) with a maturity matching the investment horizon. In DCF valuation, it is the baseline return — the rate you would demand if the investment carried zero risk. It is one of the three components of the cost of equity in the Capital Asset Pricing Model (CAPM): Cost of equity = Rf + β(Rm − Rf), where Rf is the risk-free rate.

Key takeaways​

  • The risk-free rate should match the time horizon of your valuation (5-year analysis → 5-year Treasury; 30-year → 30-year Treasury)
  • Maturity matching ensures the discount rate and cash flow projection period are aligned
  • Use current market yields, not historical averages, because WACC is forward-looking
  • Nominal (not real) Treasury yields are correct for nominal cash flow projections
  • The risk-free rate has moved dramatically with inflation and central bank policy; never assume it is static
  • In equity-heavy or long-duration businesses, the risk-free rate choice can swing your valuation by several percentage points

Why Treasury yields are risk-free​

Treasuries are issued by the U.S. government and paid in U.S. dollars. The U.S. can always print dollars to meet its obligations, so default risk is zero (in nominal terms). This is why Treasury yields serve as the baseline rate of return — the risk-free return — against which all other investments are measured.

Not all government bonds are risk-free. Bonds issued by countries with unstable currencies or sovereigns at risk of default (or restructuring) carry credit risk. Greece's government bonds in 2011 were not risk-free. But for the U.S., investors can confidently treat Treasuries as the risk-free benchmark.

The yield on Treasuries fluctuates with market conditions: inflation expectations, Federal Reserve policy, demand for safe assets, and global economic outlook all move Treasury yields. When inflation spikes, Treasuries yields rise. When the Federal Reserve cuts rates and markets fear recession, Treasury yields typically fall (though this can vary depending on which segment of the curve is in focus).

Matching maturity to horizon​

The most critical decision is maturity. A valuation that projects cash flows for the next 20 years should use a 20-year Treasury yield as the risk-free rate, not a 2-year yield. The logic is intuitive: if you discount 20 years of cash flows using a 2-year rate, you ignore the interest rate risk over the long period and underestimate the required return for long-duration assets.

For typical business valuations (10–30 year projections), the 10-year Treasury is the standard choice. The 10-year has deep liquidity, is widely published, and aligns with a medium-to-long-term investment horizon. For companies in stable, predictable industries, a 10-year horizon is reasonable.

For shorter-duration projects (3–5 year investment thesis, distressed situations, turnarounds), the 5-year or 7-year Treasury might be more appropriate. The key is consistency: your cash flow projection horizon should match your discount rate horizon.

For very long-duration assets (utilities, infrastructure, REITs with 30+ year cash flows), the 20-year or 30-year Treasury is technically correct. However, these instruments trade less frequently and the 20–30 year portion of the curve can be volatile. In practice, many analysts cap at the 10-year or 30-year when they exist; rarely does one go beyond 30 years.

Nominal vs real rates​

The discount rate in a DCF should match the cash flow projection. If you project nominal cash flows (in future dollars, including inflation), use the nominal Treasury yield. If you project real cash flows (in today's dollars, inflation-adjusted), use the real Treasury yield (TIPS — Treasury Inflation-Protected Securities).

Almost all business valuations use nominal cash flows and nominal discount rates. This is simpler and more intuitive: revenue in 2030 will be in 2030 dollars, so the discount rate should reflect the nominal return investors expect.

The relationship is:

Nominal rate ≈ Real rate + Inflation expectation

For example, if the 10-year Treasury yields 4.5% and inflation expectations (derived from TIPS and CPI-linked markets) are 2.2%, the implied real rate is roughly 2.3%. For a DCF using nominal cash flows, use 4.5%, not 2.3%.

Observing current rates​

The simplest way to find the current risk-free rate is to look up Treasury yields on any financial data source: the Federal Reserve's website, Bloomberg, Yahoo Finance, the U.S. Treasury website, or trading platforms like Interactive Brokers. As of early 2026, the 10-year Treasury is roughly 4.5%–4.7%.

Be precise: use the actual trading yield for the maturity you choose, not a month-old projection or an analyst's guess. Treasury markets are liquid and transparent; the current yield is always available.

If you are building a DCF model and want to assume a normalized or forward-looking rate rather than today's spot rate, document it. For instance, if today's 10-year yield is 4.5% but you believe it will normalize to 4.0% over your forecast period, you might use 4.2% as a blended assumption. This is reasonable, but be explicit about your assumption and test sensitivity to it.

How inflation and Fed policy drive rates​

Treasuries are sensitive to inflation because investors demand higher yields to protect against the erosion of their purchasing power. In 2022, when inflation spiked to 9% and the Federal Reserve began aggressive rate hikes, the 10-year Treasury spiked from 1.5% to over 4.0%. Conversely, in 2020, during the pandemic, as fears of deflation and recession mounted, the 10-year fell below 0.5%.

The Federal Reserve also influences rates through its discount rate (the rate at which banks can borrow overnight) and its balance sheet operations. When the Fed signals it will keep rates low for a long time, Treasury yields tend to fall. When it signals rate hikes, they rise.

For valuation, the implication is that the risk-free rate is time-varying and depends on your forecast of inflation and monetary policy. Using a 10-year Treasury yield of 4.5% in a DCF model means you are implicitly forecasting that nominal returns (inflation plus real growth) will average around 4.5% over the next decade. If you think inflation will exceed expectations, use a higher rate; if you think it will undershoot, use a lower one.

The practical choice: one rate or a curve?​

Most DCF models use a single risk-free rate for the entire valuation period. This is simpler and is the standard approach. However, more sophisticated analysts sometimes use a spot curve: a 10-year rate for years 1–10, then a longer rate thereafter (reflecting the true time value of cash flow in year 20+).

For beginners and most practitioners, a single 10-year Treasury yield works well and avoids overthinking. If your model is very long-duration (30+ years), using the 30-year Treasury might be appropriate; the choice is less critical than maturity matching.

Common pitfalls​

Using a historical average instead of current yield. The risk-free rate should be forward-looking. If you use the historical average of 10-year Treasury yields over the past 30 years (roughly 3.5%), you may be underestimating the current required return if today's 10-year is 4.5%. Historical averages are useful for stress-testing, not for the base case.

Forgetting real rates in high-inflation environments. During periods of very high expected inflation, a nominal risk-free rate of 5% might reflect 3% real + 2% inflation. If inflation disappoints and falls to 1%, the real return was 4%. This does not break your valuation, but it explains why real returns vary. Using a real rate of 3% for a 50-year infrastructure project is also valid, as long as you discount real cash flows.

Mismatching maturity and horizon. If you project cash flows for 25 years but use a 5-year Treasury rate, you are misaligned. The 5-year rate includes an assumption that you will refinance your capital in 5 years at an unknown future rate, which you are not modeling. Use a longer rate that corresponds to your horizon.

Ignoring time-varying rates in long models. In multi-decade valuations, you could argue that the risk-free rate in year 20 should reflect a 20-year Treasury yield at that time, not today's 10-year. However, this adds complexity and introduces another uncertain parameter (future rate paths). Most practitioners stick with one current rate, implicitly assuming rates revert to some long-term level. Document your assumption.

Using nominal rates with real cash flows (or vice versa). Mixing nominal rates with real cash flows, or real rates with nominal cash flows, breaks the math and gives nonsense valuations. Be consistent: nominal rate with nominal cash flows, real rate with real cash flows.

Building the Discount Rate​

Real-world examples​

Valuing Apple in early 2026. The 10-year Treasury is 4.5%. A DCF of Apple over 10 years would use 4.5% as Rf, the foundation of the cost of equity. If Apple's beta is 1.2 and the equity risk premium is 5.5%, cost of equity = 4.5% + 1.2 × 5.5% = 11.1%. The WACC (after blending in cost of debt) might be 8.5%.

Valuing a railroad. Railroads have long asset lives (30+ years). The DCF might span 30 years. Here, using a 30-year Treasury (if liquid) or a blended 10–30 year rate is more appropriate. If the 10-year is 4.5% and the 30-year is 4.3% (reflecting a slight long-end discount), a 25-year average of 4.4% might be used.

During the 2020 pandemic. When the 10-year Treasury fell below 0.5%, many analysts felt that discount rates were artificially suppressed. Some added a "normalized" risk-free rate of 1.5%–2.0% for their base case, reasoning that Treasury yields would revert to long-term norms. This was a choice about forward-looking rate assumptions, not a mistake; the key was documenting the assumption.

FAQ​

Q: If real rates are negative (Treasury yields minus inflation expectations), should I use a negative discount rate? A: No. Negative real rates can exist in markets (as they did in 2021–2023), but they reflect equilibrium between supply and demand for safe assets and inflation fears. For a DCF using nominal cash flows, use the nominal Treasury yield, which will be positive. If you are modeling real cash flows, you can use a negative real rate (it means investors are willing to accept a loss in purchasing power to hold safe assets), but this is rare in equity valuations.

Q: Should I use a different risk-free rate for each division or segment of a conglomerate? A: No. The risk-free rate is the same across all equity valuations in a currency (e.g., all U.S. equity valuations use the U.S. Treasury rate). It is the cost of equity that varies by division (beta differs), not the risk-free baseline. However, if you are valuing international divisions, you might use the local currency risk-free rate and apply a currency adjustment.

Q: What if I am valuing a company with cash flows in multiple currencies? A: Use the risk-free rate of the country whose currency the cash flows are in. For a multi-currency DCF, value each segment in its local currency, discount using the local risk-free rate, and convert back to the reporting currency. Alternatively, hedge the foreign currency exposure and use a single rate in the reporting currency.

Q: How sensitive is my valuation to the risk-free rate? A: Very. Every 1% change in the discount rate has a large effect on the present value of long-dated cash flows. A company with cash flows heavily weighted to years 10–30 might be 15–25% more valuable if the risk-free rate drops from 5% to 4%. This is why sensitivity analysis (testing your valuation across a range of discount rates) is essential.

Q: Can I use the yield curve to forecast future rates for my DCF? A: The yield curve reflects market expectations. If the 10-year Treasury is 4.5% and the 2-year is 4.0%, markets are implying that rates will fall over the next 2 years. Some analysts use this to model declining rates over time. However, this adds complexity and is speculative. Most use a flat (constant) rate assumption, which is simpler and avoids forecasting bets on rate changes.

Q: I see SOFR rates in the news. Should I use SOFR instead of Treasuries for the risk-free rate? A: No. SOFR is the Secured Overnight Financing Rate, a short-term lending rate in the interbank market. It is not risk-free in the way Treasuries are; it reflects credit and liquidity risk of banks. Treasuries are the risk-free baseline for long-term valuations. SOFR is replacing LIBOR for floating-rate loans and bonds, but it is not the foundation for equity valuations.

  • Cost of Equity and CAPM — The risk-free rate is the baseline; beta and the equity risk premium add risk-adjusted returns.
  • Yield Curve and Interest Rates — Understanding how Treasury yields across maturities reflect economic expectations.
  • Inflation Expectations — The gap between nominal and real yields, and how it informs forward-looking assumptions.
  • WACC (Weighted Average Cost of Capital) — The risk-free rate feeds into both cost of equity and cost of debt.
  • Duration and Interest Rate Risk — Why long-duration assets are sensitive to changes in the risk-free rate.
  • Monetary Policy and Rates — How Federal Reserve decisions influence Treasury yields and the discount rate.

Summary​

The risk-free rate is the yield on U.S. Treasuries, and selecting it correctly is critical to a sound DCF. Use the current market yield (not a historical average) on the Treasury maturity that matches your investment horizon. For most business valuations, the 10-year Treasury is the standard. Use nominal yields with nominal cash flows, and ensure that maturity and horizon align. Small changes in the risk-free rate have large effects on value, so test sensitivity across a reasonable range of rates and document your assumptions.

Next​

The risk-free rate is half of the cost of equity equation. The other half is the equity risk premium — the additional return investors demand for bearing stock market risk instead of holding Treasuries. The next article explains where this premium comes from and how to estimate it.

→ The equity risk premium