The discount rate is a key concept in the discounted cash flow (DCF) analysis, which is used to determine the present value of future cash flows. It is a measure of risk and potential returns, with higher rates indicating more risk but also higher potential returns. Most investors use a discount rate between 7.5% and 9.5%, while private companies in their early stages usually have a discount rate of more than 30%. The cost of capital, which is calculated using the capital asset pricing model (CAPM), is typically used as a discount rate when budgeting for a new project.
The formula for the cost of shares is the risk-free rate of return plus the share price beta multiplied by the market rate of return (minus the risk-free rate of return). When creating a discounted cash flow (DCF) model, finance classes typically use a company's weighted average cost of capital (WACC) as a discount rate. Future cash flows are reduced based on the discount rate, so the higher the discount rate, the lower the present value of future cash flows. For example, if you adjust the discount rate to 7% or 9% for Siri (SIRI), you can see how using a high discount rate will give a lower rating than a low discount rate.
It is important to note that there is no one-size-fits-all answer when it comes to choosing an appropriate discount rate. The best approach is to consider all factors such as risk, potential returns, and company size before making a decision. This will help ensure that you are making an informed decision that will benefit your business in the long run.
