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Isaac Chan
12 Mar 2019
Business at NUS
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The common method to determine discount rates is to use the weighted average cost of capital (WACC). WACC is a blend of the cost of equity and the after-tax cost of debt, in other words WAVV is the average cost of raising money to finance the company. The WACC is calculated by multiplying cost of debt and equity by its relevant weight and adding products together.
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If you are using the dividend discount model, then you would need to use the required return on equity as your discount rate. This is because these returns are based on the "equity" portion of the balance sheet, and not debt. In this case, WACC wouldn't be the appropriate discount rate.
Discount rates should reflect the opportunity costs of investing in something else of a similar risk type. Hence, the type of discount rates used and the different premiums used for the discounting would be different.