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Different discount rates

0

01hoatherm

Member
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.
 
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