What's a typical discount rate right now?

Discussion in 'Accounts & Finance' started by Cornish Steve, Dec 1, 2011.

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  1. Cornish Steve

    Cornish Steve Contributor

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    When calculating NPV, what is a typical discount rate right now? Clearly, government bond rates are ridiculously low. Does that translate into a lower discount rate in business - or is 10% still a typical value?
     
    Posted: Dec 1, 2011 By: Cornish Steve Member since: Jul 4, 2005
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  2. cjd

    cjd Verified Business ✔️
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    Depends what your business is, what investment period you're interested in and what your individual cost of capital is. If this is a real decision, rather than an accademic problem, i'd find out what I could borrow at and use that, establish what IRR is actually achieved and do sensitivity testing around it.

    If it's over a longish period, a bigger problem than CoC is going to be your estimation of inflation as it's likley that it will be higher than interest rates and will make a mess of any numbers you produce if wrong.
     
    Posted: Dec 1, 2011 By: cjd Member since: Nov 23, 2005
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  3. Cornish Steve

    Cornish Steve Contributor

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    Let me ask the question in a different way: If you offered a customer the option to pay in 12 months' time versus paying now, what discount would you offer for paying now?
     
    Posted: Dec 1, 2011 By: Cornish Steve Member since: Jul 4, 2005
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  4. cjd

    cjd Verified Business ✔️
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    That's not just asking the question in a different way, it's asking a totally different question - it's become a marketing problem instead of an investment decision :)

    So it's completely up to you and depends on your own finance costs, the risk in lending to your customer, the margin on the goods, the total likely sales etc etc.

    In the UK you can only get about 2-3% interest on a 12 month accessible account so if you're cash rich you could lend at that rate. (You'll need to factor in bad debts). But if you need to borrow it's going to be at least double that probably more - if you actually can.

    The inflation problem means that if you sell something now but delay your income for 12 months the cost of replenishing stock will have risen by whatever it turns out to have been.

    In short, just guess at what looks attractive to a customer.
     
    Posted: Dec 1, 2011 By: cjd Member since: Nov 23, 2005
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  5. talkinpeace

    talkinpeace Contributor

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    I read a very interesting article in the economist that said for many events, there should be no DCF factor nowadays as returns are very low and discounting encourages short termism
    (and fiddled discount factors are part of what got us into the PFI mess)
     
    Posted: Dec 1, 2011 By: talkinpeace Member since: Jan 3, 2009
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  6. Cornish Steve

    Cornish Steve Contributor

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    Not really. The discount rate applied to cash flow is sometimes used to justify the discount rate for prepayment versus deferred payment. It used to be that a number in the range 10-15% was appropriate. With interest rates so very low, however, I can't see how a company can justify more than the 2-3% figure you quote.
     
    Posted: Dec 2, 2011 By: Cornish Steve Member since: Jul 4, 2005
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  7. cjd

    cjd Verified Business ✔️
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    But what are you trying to achieve? Are you trying to get a customer to pay early to help cash flow? (in which case you might offer him 5% or more depending on your own cost of borrowing, the state of your accounts and the margin on the sale) or are you cash rich and can therefore afford to lose a notional 2% interest inorder to have the marketing message "nothing to pay for 12 months, then easy terms"?
     
    Posted: Dec 2, 2011 By: cjd Member since: Nov 23, 2005
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