Myth 4.4: The D(discount) rate is a receptacle for your hopes and fears
aswathdamodaran.substack.com
In discounted cash flow valuation, discount rates are the instruments that we use to adjust for the risk in cash flows. In practice, discount rates often take on a far greater role. Some analysts use them to bring in the quality of management, pushing down discount rates for what they perceive as well-managed firms and pushing up discount rates for poor management. Venture capitalists pump up discount rates to compensate themselves for failure risk, i.e., that many of the firms that they invest in will not make it. While these adjustments may seem intuitive, they are dangerous for many reasons: you can double count both the good and bad, you may be adjusting for risks you should not be and biasing your valuations.
Myth 4.4: The D(discount) rate is a receptacle for your hopes and fears
Myth 4.4: The D(discount) rate is a…
Myth 4.4: The D(discount) rate is a receptacle for your hopes and fears
In discounted cash flow valuation, discount rates are the instruments that we use to adjust for the risk in cash flows. In practice, discount rates often take on a far greater role. Some analysts use them to bring in the quality of management, pushing down discount rates for what they perceive as well-managed firms and pushing up discount rates for poor management. Venture capitalists pump up discount rates to compensate themselves for failure risk, i.e., that many of the firms that they invest in will not make it. While these adjustments may seem intuitive, they are dangerous for many reasons: you can double count both the good and bad, you may be adjusting for risks you should not be and biasing your valuations.