Sunday, February 5, 2023

Which discount rate should you use? (HINT: not the one you have been taught to use)

 Via Marginal Revolution:  

The key purpose of corporate finance is to provide methods to compute the value of projects. The baseline textbook recommendation is to use the Present Value (PV) formula of expected cash flows, with a discount rate based on the CAPM.
However:
We find that discounting based on expected returns (such as variants on the CAPM or multi-factor model), performs very poorly. Discounting with an Implied Cost of Capital (ICC), imputed from comparable firms, obtains much better results.

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