Glossarytaught in M3.01, M3.03
Discount rate
Also called required return, hurdle rate.
The annual return an investor requires for putting money at risk, and the rate at which future cash flows are converted back to today.
For an equity cash flow it's the cost of equity: a risk-free rate plus a premium for bearing equity risk, scaled by how much of that risk this particular business carries. At a 7% risk-free rate, a 5.5% equity risk premium and a beta of 1.1, you get a cost of equity of 13.05%.
If the cash flow belongs to lenders and owners together, you use the weighted average cost of capital instead.
Match the rate to whose money the cash flow is.
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