corporate-finance
A discount rate is the required return used to convert future cash into present value. In firm DCF it is usually WACC; in equity DCF it is the cost of equity. It must match the risk and the currency of the cash flows being discounted.
A discount rate answers: how much less is a euro in year 5 worth than a euro today, given that it may not arrive? It combines time (the risk-free component) and risk (spreads, betas, premia). In valuation it is not a moral hurdle and not automatically the IRR a fund has promised LPs.
Matching rules, drilled in CFA materials and Damodaran's teaching:
| Cash flow | Typical discount rate |
|---|---|
| FCFF (unlevered, after-tax operating) | WACC |
| FCFE | Cost of equity |
| Contractual debt cash flows | Yield on that debt |
| IAS 36 value in use | Pre- or post-tax rate applied consistently to the cash flows |
| Synergy cash flows | Often a higher rate, or probability-weight the cash |
Currency match: EUR cash flows get a EUR rate. Inflation match: real cash with a real rate; nominal with nominal. Mixing is a quiet killer of intrinsic value.
A private-equity "15% discount rate" on levered equity is a fund opportunity cost, including illiquidity and the fund's leverage plan. Using it as the firm's WACC in an unlevered DCF will understate enterprise value for a normally geared asset. Say which rate you mean.
Invented project inside Verde Logistics: a new cold-chain corridor, illustration only.
| Choice | Rate | Why |
|---|---|---|
| Firm WACC (core logistics) | 7.8% | Existing operations |
| Project asset beta higher (new country, utilisation risk) | WACC-equivalent 10.2% | Same formula, higher β and CRP |
| Fund levered equity hurdle | 16% | Not used in the unlevered project DCF |
| Wrong: discount FCFF at 16% | Mixes claims; kills NPV by design |
The project DCF should use ~10.2% on project FCFF, then a separate financing model if they will lever it. One number cannot do both jobs.
Price and rate move inversely: 100bp on WACC often moves TV more than a year of margin. Negotiations sometimes "agree the DCF" and fight only the rate—which is a fight about risk. Credit investors have their own discount rates (yields); do not import them into equity DCFs without changing the cash-flow claim.
No single observable "correct" rate exists for a private firm. Ranges and grids are more honest than three decimals. Behavioural hurdle rates (payback, 20% because the owner said so) can be rational as decision rules and still be wrong as asset discount rates.
Dazur writes the discount rate as a matched pair: this cash flow, this rate, this currency. We keep fund hurdles on the returns page and asset WACC on the valuation page. That split prevents a process from collapsing into a single percentage that nobody can derive twice.