https://finmasters.com/how-to-determine-a-discount-rate/ Master Your Finances and Reach Your Goals Mon, 30 Oct 2023 13:11:18 +0000 hourly 1 https://wordpress.org/?v=6.4.3 https://finmasters.com/how-to-determine-a-discount-rate/#comment-820 Wed, 13 Jan 2016 14:27:46 +0000 https://www.vintagevalueinvesting.com/?p=2068#comment-820 This is always an interesting subject. Thanks for sharing.
My opinion (and I could be completely wrong here) is that valuing a business is a matter of convention. It is not like an exact science. An exact science provides both formulas and ways to measure or compute the variables to be used in the formulas. In valuing a business, all we got is a formula (for the discounted cash flows for example) but no indication on how the variables in the formula (including the cost of capital) should be computed. Consequently, we are left with the choice of what should be used as the cost of capital.
Therefore, if the aim of the exercise is to compute an absolute intrinsic value for the shares of a company, expecting that the market will eventually track this value, better to use the convention that is mostly used by the market participants – currently the CAPM. For that reason, I use the CAPM WACC in valuing businesses.
I believe one should be careful in using an expected annual rate of return as cost of capital. It seems to me we are not comparing apples with apples here. Only an IRR computation can make both identical and will implicitly imposes constraints on growth rate and earnings yield that are not apparent at first.

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