Determining the level of the discount rate

To take into account risk factors, it is desirable to consider at least three possible options for the project - "pessimistic", "optimistic" and "most likely". The same approach is relevant in assessing investment risks, when calculating project performance indicators. The speed of calculations in Budget-Plan Express is quite "comfortable" to "play" project variants, for example, using different rates (changing them in the settings). Earlier, we noted the value of the discount rate - as a certain level of risk of the "barrier" rate, and it is obvious that in the calculation of performance indicators, the boundaries of risk depend on the chosen rate. First of all, pay attention to the indicator "internal rate of return" (NPV), which determines the value of the discount rate, in which the NPV is zero.

The less the difference in the resulting financial indicators for each option, the more stable the project is to changes in external conditions, the less the risks associated with the project. When determining the discount rate, you should always pay attention to the following:

1. The ultimate meaning of using discounting in assessing cash flows (investment risks).
2. The discount rate is always an "expert" estimate, that is, any calculations and methods used to calculate the rate are just a guideline that can be adopted or adjusted.
3. The discount rate is usually correlated with different levels of risk, which are determined in most cases by investors' demands, for example, r - the discount factor, can take into account the level of investment risk (risk premium).

The easiest way to check if the bet is chosen correctly is to compare it to the deposit rates: "What is more profitable? Put money into a deposit or invest in a project? ". The overestimated discount rate determines the "safety margin" of the project, its stability in the event of a possible increase in risk. That is, the greater the estimated discount rate, the fewer risks of investing in this particular project, of course, provided positive estimates of investment performance.

When assessing the effectiveness of the project, to determine the discount rate, sometimes the following approach is practiced: the discount rate is taken not lower than the ROA of existing enterprises in the same industry and with the same type of products and not higher than the values obtained from the CAPM model. The most common, to determine the discount rate, in practice received weighted average value of capital model (WACC). As the discount rate used is the WACC figure.

☛ Note that to calculate the modified MIRR internal rate of return, the weighted average discount rate is used – for the entire calculation period selected by the user.

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