Should Practitioners (Continue to) Use a Single Discount Rate in Large-Scale Project Valuation?

Abstract

A popular, large-scale, project valuation technique relies on discounting equity cash flows using the cost of equity as a discount rate. Practitioners often use a single discount rate (SDR). Academic professionals, however, argue for the use of multiple discount rates (MDR) to reflect changes in the project’s leverage and overall risk. This article explores the state of the art in MDR valuation, reconciles the MDR and SDR valuation approaches, and develops a practical example applying some of the simplest MDR techniques available. Some conclusions are drawn regarding which approach may offer the better results.

TOPICS: Project finance, legal/regulatory/public policy