What Discount Rate Should You Use?

When it comes to making financial decisions, the discount rate is an essential factor to consider. This rate is used to calculate the net present value (NPV) of a company as part of a discounted cash flow (DCF) analysis. The discount rate is a critical input in the DCF model; in fact, it is arguably the most influential factor for the value derived from the DCF. In corporate finance, a discount rate is the rate of return used to discount future cash flows to their current value.

This rate is usually a company's weighted average cost of capital (WACC), the required rate of return, or the limit rate investors expect to obtain relative to investment risk. In other words, the discount rate should be equal to the level of return currently produced by similar stabilized investments. It would be difficult to argue for a discount rate of less than 5%, since very few marketing environments are as stable and predictable in today's world. A 10% discount rate is commonly used, as it is generally based on the return companies derive from their other investments.

When it comes to truly usable discount rates, expect them to be within a range of 6 to 12%. If we know that the cash return for the next best investment (opportunity cost) is 8%, then we should use an 8% discount rate. If you choose to use a high discount rate, such as 12% or 15%, to discount future cash, it just means that you're willing to pay less today for future cash. The cost of many potential greenhouse gas reduction actions could fall within this range of investments that would be considered valuable at the highest value of SCC (calculated with a lower discount rate) but not at the lowest (calculated with a higher discount rate).

The current value of the benefits of this wind farm will vary depending on the discount rate used, while the current value of the cost will not be significantly affected by the discount rate. Once all cash flows are discounted to the current date, the sum of all future discounted cash flows represents the implied intrinsic value of an investment, usually a public company. For simplicity, I'm just going to adjust the discount rate to see the effect of changes in the discount rate. You can see how using a high discount rate will give a lower rating than a low discount rate, as in the previous example with SIRI. 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. In conclusion, when it comes to choosing a discount rate for your financial decisions, it's important to consider your opportunity cost and use that as your guide.

The range of 6-12% is generally accepted as being suitable for most investments and should be taken into account when making decisions.