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Discount rate considerations

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"The boss" had come back from Starbucks perplexed and now excited. On her desk was a memo from the CEO inviting her to join the Company's strategy steering committee and her first task.

CEO looking thrugh a magnifying glass at the discount ratesThe CEO writes about his concerns with recent new product release failures and the process used to screen new ideas. For years, new ideas had been funded out of sales revenues as the company grew, but it looks like he will need to borrow money within the next year to fund new product introductions. For the next meeting, he had asked her to lead a discussion on what discount rate to use in the NPV and terminal value calculations. He needs to provide guidance for the next strategy retreat, in a month, and wants a leadership perspective.

The CFO also sent a memo suggesting three rates to consider: our traditional hurdle rate, our weighted average cost of capital, or our industry's weighted average cost of capital.

&quotTthe boss" perplexed by revisitng her finance trainingUnfortunately, her last finance course taken was twelve years ago. It was off to Google to recall the terms and to to buy a good book or two on the subject. The gray haired contrarian recommended Martha Amram's Value Sweep, Chapter Three, for a simple method and Alfred Rappaport's Creating Shareholders Value for the nuisances. Industry data, data sources and a comprehensive discussion of calculation methods could be found at Prof. Aswath Damadoran's valuation site at NYU.

At this point, her best tactic for the meeting would be to ask informed questions and understand the relationships. Why wasn't the CFO leading the discussion?

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