Thursday, July 4, 2024.
As business owners and/or directors, we are constantly focused on maximizing the value of our companies and making informed decisions that enhance value. The primary tool for determining the value of a company is discounted cash flow, which discounts future cash flows at a discounted rate.
However, a question arises, "How important is the construction of the discount rate in DCF?"
Let me emphasize this: is essential.
The discount rate in most cases of company valuation is the: Weighted Average Cost of Capital (WACC). Weighted Average Cost of Capital), is not simply a number, but a reflection of the risks and expectations of your business.
Risk and Opportunity Cost Capture
The discount rate incorporates the cost of equity and debt capital, considering the risks associated with your business and your specific industry. This reflects what investors expect to earn as a return for investing in your company, thus representing the opportunity cost of investing capital elsewhere considering the level of investment risk.
Influence on Valorization Results
A small change in the discount rate can lead to a significant change in valuation. A higher discount rate leads to a lower present value of future cash flows, and vice versa. This sensitivity underscores the need for precision in estimating this rate.
Adaptation to Your Business
The benchmarks industry generics are not enough. Your company's unique characteristics, growth prospects and financial structure must be considered. This customized approach ensures that the discount rate accurately reflects the risks and potential of your business.
Rationale for Strategic Decisions
Whether evaluating an acquisition, making capital raising decisions or assessing the viability of a new project, the discount rate serves as the foundation. It determines whether an investment will create value and should be undertaken or whether it destroys value within the company.
Generation of Trust
A rigorously constructed discount rate provides the stakeholdersincluding investors and potential buyers, confidence in your financial evaluations. Demonstrates a deep understanding of the financial dynamics of your business.
The construction of the WACC is not just a technical exercise, as it directly influences how your business is valued, the decisions you make and the confidence stakeholders have in your company.
To ensure an accurate and strategic valuation of your company, it is important to have the right tools and information to calculate the discount rate. At Valoriza we have the experience and robust methodologies to ensure that the discount rate accurately reflects the risks and opportunities of your business. If you want to learn more about how to value your company, do not hesitate to contact us at.
Fernando Tamblay M
Valoriza Partner
Commercial Engineer from Universidad de Chile, with more than 10 years of experience in valuation of companies and investment funds. Specialist in valuations for tax and regulatory purposes.
