Using the discount rate in the analysis of the weighted average cost of capital
Abstract. Within the framework of the article, the author raises a problem of using the discount rate when analyzing the weighted average cost of capital. The discount rate is the interest rate that is used to determine the present value of future cash flows. When analyzing the weighted average cost of capital (WACC), the discount rate is used as an estimate of the value of money over time and as an indicator of how risky investing in a particular project or company is. WACC is a weighted sum of the cost of capital and borrowed funds used by a company to finance its projects. To calculate the WACC, it is necessary to determine the cost of capital and the cost of borrowed funds and then multiply each of these costs by its weight in a unit of value. To calculate the cost of capital, the income capitalization formula (CAPM) is used, which takes into account market risks and the expected return of investors on the securities market. The CAPM formula includes a risk-free return rate, a risk premium and a company beta. The weighted average cost of capital is an important indicator for evaluating the effectiveness of investments and making decisions on financing projects. The use of the discount rate in the analysis of the weighted average cost of capital is one of the key components of this process.
Keywords: discount rate, weighted average cost of capital, risk, investment.
Highlights:
♦ the discount rate reflects the minimum return that an investor requires from his investments;
♦ using the discount rate in the WACC analysis allows companies to determine how effectively they use their capital, and how risky investing in their projects is;
♦ using the discount rate when analyzing the weighted average cost of capital can also help investors assess how profitable it is to invest in a particular company or project and what risks are associated with it.
Zhaslan R. Abdilmanov - Investment and Consulting company «Bearox», Astana, Republic of Kazakhstan