How often do you just stick 8.0% in as your discount rate as you analyze and compare leases? Every wonder how you could actually calculate what the discount rate should be.
Well, you’ve come to the right place. This discount rate is the company’s Weighted Average Cost of Capital, or “WACC”. In the simplest terms, WACC is the rate of return which the company needs to achieve in order to achieve their equity investors and bondholders expectations.
In an ideal world, this rate of return represents the overall return on investments in the company’s core business.
Here is the underlying formula –
MVe = the market value of equity outstanding
MVd = the market value of debt outstanding
Re = the company’s cost of equity
Rd = the company’s cost of debt
t = the company’s effective tax rate
Source: Wikipedia
The problem is, unless you (or your client) is a publicly-traded company, very few company executives actually know their own WACC.
So, without doing significant research and performing some pretty intense algebra, it’d be tough to come up with an accurate discount rate for every lease analysis you perform.
Lucky enough for us, this type of research is relatively easy to find, if you know where to look. The table below uses data from the NYU Stern School of Business.
Scroll table down for more industries or view the entire table here.
Within this table, two columns are highlighted. The first column is the WACC before the industry’s average effective tax rate, the second highlighted column is the industry’s after tax WACC.
It is important to make sure that you use the before tax WACC to discount before tax cash flows, or the after tax WACC to discount after tax cash flows.
