The discount rate: the price of waiting and risk

0 of 28 lessons checked

Key idea: The discount rate is the yearly return an owner demands for waiting and for taking risk. Riskier businesses get higher rates and lower values.

The discount rate is the yearly return you require to tie up money in a business. It has two parts: what you could earn on very safe assets, such as government bonds, plus an extra amount for the risk of owning this particular company.

Professionals often use the weighted average cost of capital (WACC), which blends what the company's lenders charge with what its shareholders require. A steady utility might sit around 6-7%. A young company with uncertain profits might be 11-13% or more.

The rate matters enormously. Cash flows of $10 a year forever are worth $10 / 0.08 = $125 at an 8% rate, but only $10 / 0.10 = $100 at 10%. Two percentage points knocked 20% off the value.

This is also why rising interest rates tend to pull share prices down across the board: the safe part of everyone's discount rate went up.

Quick check

A stream of $5 a year forever is valued at a 5% discount rate. What is it worth?

Work out a discount rate with the WACC calculator →

Get the next lesson in your inbox tomorrow

Educational content only, not investment advice. Examples use made-up or historical figures.

Educational Use Only — Not Financial Advice

All content, analysis, valuations, options strategies, AI-generated commentary, screener results, and other information provided by Equity Rank is for informational and educational purposes only. Nothing on this platform constitutes financial advice, investment advice, trading advice, or any other type of advice. Equity Rank is not a registered investment adviser, broker-dealer, or financial planner under any applicable law or regulation.

Valuation models, margin of safety percentages, fair value estimates, options strategy outputs, and AI analysis are algorithmic outputs based on publicly available data and do not represent personalized investment recommendations. All financial models contain assumptions that may be incorrect. Past performance of any security is not indicative of future results. You may lose money on any investment.

Every fair value figure on Equity Rank is our model’s opinion of a company’s intrinsic worth under stated assumptions — it is not a prediction, forecast, or price target for where the security will actually trade. Fair value estimates describe what the model considers a business to be worth today, not where its market price is headed. Actual market prices are set by supply and demand and by factors no model can fully capture, and may differ materially and indefinitely from any fair value shown here.

Always conduct your own independent due diligence. Consult a licensed financial advisor, tax professional, or attorney before making any investment or financial decision. By using Equity Rank, you acknowledge that you understand and accept these limitations. Portfolio model outputs are mathematical results of quantitative algorithms and do not represent investment recommendations.