Question: Why the discount rate equals the opportunity cost of capital?

Why is this “opportunity cost of capital” always the right rate at which to discount cash flow? If you discount at a rate r < opportunity cost of capital then intuitively you would be willing to spend more to create the cash flow than you could just buy the same cash flow for in the market.

Is discount rate equal to cost of capital?

The discount rate is the interest rate used to determine the present value of future cash flows in a discounted cash flow (DCF) analysis. … The cost of capital is the minimum rate needed to justify the cost of a new venture, where the discount rate is the number that needs to meet or exceed the cost of capital.

Is discount rate the same as CAPM?

One such model is the CAPM. The CAPM, derived by Sharpe (1964) and Lintner (1965) provides the following discount rate: Here, ke is the discount rate, rf is the risk free interest rate, b is the stock’s beta (i.e., sensitivity to overall market movements), and E(RM) is the expected return from the market as a whole.

IT IS INTERESTING:  You asked: Do Sprint employees get free phones?

What is the discount rate equal to?

In this context of DCF analysis, the discount rate refers to the interest rate used to determine the present value. For example, $100 invested today in a savings scheme that offers a 10% interest rate will grow to $110.

Is opportunity cost the same as cost of capital?

As opposed to strictly using cost of capital, decisions must be made using opportunity cost of capital. Opportunity cost of capital is the amount of money foregone by investing in one asset compared to another. As an investor, this can simply be a choice of one asset over another.

What are the factors affecting cost of capital?

Following are the main factors which affects cost of capital.

  • Current Economic Conditions. …
  • Current Capital Structure. …
  • Current Dividend Policy. …
  • Getting of New Fund. …
  • Financial and Investment Decisions. …
  • Current Income Tax Rates. …
  • Breakpoint of Marginal Cost of Capital.

What is the difference between WACC and cost of capital?

What is the difference between Cost of Capital and WACC? Cost of capital is the total of cost of debt and cost of equity, whereas WACC is the weighted average of these costs derived as a proportion of debt and equity held in the firm.

What is a good discount rate to use for NPV?

It’s the rate of return that the investors expect or the cost of borrowing money. If shareholders expect a 12% return, that is the discount rate the company will use to calculate NPV.

Can you use CAPM as discount rate?

As mentioned in the first article, the CAPM is a method of calculating the return required on an investment, based on an assessment of its risk. … Instead, the CAPM can be used to calculate a project-specific discount rate that reflects the business risk of the investment project.

IT IS INTERESTING:  Which Vegas hotels have AAA discounts?

What happens when discount rate increases?

The net effects of raising the discount rate will be a decrease in the amount of reserves in the banking system. Fewer reserves will support fewer loans; the money supply will fall and market interest rates will rise. If the central bank lowers the discount rate it charges to banks, the process works in reverse.

What is a good discount rate?

Usually within 6-12%. For investors, the cost of capital is a discount rate to value a business. Don’t forget margin of safety. A high discount rate is not a margin of safety.

How do I calculate a discount rate?

To calculate the percentage discount between two prices, follow these steps:

  1. Subtract the post-discount price from the pre-discount price.
  2. Divide this new number by the pre-discount price.
  3. Multiply the resultant number by 100.
  4. Be proud of your mathematical abilities.
Bargain purchases