Discounting is a method of determining the future value of cash flows, i.e. bringing the volume of future income to the present moment. In order to correctly assess their value, it is necessary to know the forecasted values of proceeds, expenses, investments, the capital structure and the discount rate, i.e. the rate of return on the invested capital.
Instructions
Step 1
Most often, the discount rate is determined as the weighted average cost of capital. When using this method, you will get the most objective result. To calculate the discount rate, use the following formula: WACC = Re (E / V) + Rd (D / V) (1-Tc), where Re is the rate of return on equity (cost of equity),%; E is the market value of equity; D - market value of borrowed capital; V - total cost of borrowed capital and company shares (equity capital); Rd - rate of return on borrowed capital (cost of borrowed capital); Tc - income tax rate.
Step 2
You can calculate the equity capital discount rate as follows: Re = Rf + b (Rm-Rf), where Rf is the nominal risk-free rate of return; Rm is the average rate of return on the stock market; (Rm-Rf) is the market risk premium; b is a coefficient showing the change in the price of a firm's stock compared to changes in stock prices in a given market segment. In countries with a developed stock market, this ratio is calculated by specialized analytical agencies.
Step 3
However, please note that this approach does not allow calculating the discount rate for all businesses. It does not apply to companies that are not open joint stock companies, i.e. do not trade stocks on the market. In addition, it cannot be used by firms that do not have data to calculate their b-coefficient. In these cases, businesses should use a different method of calculating the discount rate.
Step 4
The cumulative method for estimating the risk premium is based on two assumptions. First, if investments were risk-free, then investors would demand a risk-free return on their capital. Secondly, the higher the owner of capital assesses the risk of the project, the higher the requirements for profitability. Based on this, the discount rate is determined as follows: R = Rf + R1 +.. + Rn, where Rf is the nominal risk-free rate of return; R1.. Rn are the risk premiums for various factors. The presence of each factor and their value are determined by experts. This method is more subjective, since the value of the risk premium depends on the personal opinion of the expert.
