Discount rate is necessary number when DCF is used. It shows expectation of return of investment from investors, which also means the level of risk. The higher discount rate is, the higher risk is generally. WACC is normally used as discount rate in corporate finance.
rE: equity cost
rD: Debt cost
D: The amount of net debt
E: The amount of net asset
T: Effective tax rate
The meaning of WACC@
WACC shows the cost when the company raises money as debt or equity. WACC is calculated as weighted average between debt cost and equity cost.
Debt cost is calculated as below.
rD = interest rate of the debt
Normally, net value of a debt is equivalent of book value of the debt because
it wouldn't be changed compared with asset. Debt cost is affected by tax
shield, it shows the formula, rD * (1-T).
When Equity cost is calculated, CAPM (Capital Asset Pricing Model) is used.
CAPM is calculated as below.
rE = risk free rate - Beta * risk premium = risk free rate - beta * (market risk - risk free rate)
Risk free rate: Interest rate of long-period bond (General method)
Market risk: Past rate of return in the stock market
Beta: Fluctuation risk of individual stock / that of whole market (Each
company has different Beta.)
Beta means risk of stock of a company compared with risk of market so the more Beta is, the more risk the company has.
Principle of Finance FCF (Free Cash Flow) DCF (Discount Cash Flow) WACC Beta Unlevered Beta IRR Terminal Value Disadvantages of WACC APV (Adjusted present value) Method
Making Portfolio and Diversification of Risk 1
Making Portfolio and Diversification of Risk 2
Return analysis by DCF 1
Return analysis by DCF 2
Important Indicator of DCF
Optimized Debt Equity Ratio
Tax Shield by Debt
Types of Debt
Policy of Dividend
Relationship between Policy of Dividend & Stock Price
Relationship between Own Shares Purchase & Stock Price
Investment to raise Stock Price
Bond with Warrant
Comparison of Yield Rate among Several Bonds
Effect of M&A
Financing in M&A
Process of Purchasing Stock Price in M&A
Types of Selling Business
LBO (Leveraged Buy Out)
MBO (Management Buy Out)
PPA (Purchase Price Allocation)
PMI (Post Merger Integration)