Hi there, I get a bit confused when discounting cashflows for various purposes: Sometimes, the discount rate is the risk-free-rate adjusted to allow for risk [*]Other times, the discount rate reflects the investment strategy/underlying assets When is each rate used (and why?)? Thanks
join the club! Often it boils down to the approach being used. If market consistent then usually start with risk-free rate. If real-world calibration (ie not market-consistent = traditional) then use shareholders required rate of return (which could be derived in a number of ways, eg risk-free plus margin). Also consider what the rate is being used for - eg are we accumulating cash flows to reflect actual expected return - or are we discounting profits using a RDR. It's only the latter where we might use risk-free plus margin for risk. If you want a prudent margin when accumulating, you'll want to use a lower rate. Often no one way of doing things.
