Musings on Markets · 2016-11-04 · 3499d

Time-Varying Discount Rates in DCF Valuation: Why the Cost of Capital Should Change Over Time

This article challenges the common misconception that discount rates must remain constant throughout a DCF valuation. The author argues that discount rates should adjust over time to reflect changing company characteristics such as growth, business mix, and risk profile, demonstrating significant valuation impacts across different company types.

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Metrics in this report

Cost of Equity Example - Average Risk US Company

7.6%

calculated

October 2016, with 1.6% risk-free rate and 6% equity risk premium

Equity Value Impact - Growth in Transition

20.91%

increase with time-varying vs constant discount rates

Tesla valuation (July 2016)

Equity Value Impact - Mature Company

8.59%

increase with time-varying vs constant discount rates

Apple valuation (May 2016)

Equity Value Impact - Young Growth Company

38.91%

increase with time-varying vs constant discount rates

Uber valuation (June 2014)

Mature Market Equity Risk Premium

6%

observed

October 2016

Risk-Free Rate

1.6%

observed

US dollar, October 2016