You have just been hired by a large Investment Holding Company and you have been told to evaluate the potential acquisition of XYZ Company (a public company).

You have decided to use a DCF (discounted cash flow) methodology and have been discussing with colleagues the appropriate discount rate to use to value the company. Your supervisor (who has little finance experience) overhears your conversations and instructs you to use a 10% discount rate and justifies this by saying that this is the rate they use (and have used for the past 30 years).

You are concerned that your supervisor is providing you with bad guidance with respect to the 10% discount rate they have told you to use.

 

Questions that you need to answer in your PowerPoint:

1. Explain to your supervisor why you believe the 10% discount rate may be incorrect, and what the discount rate is meant to represents.
2. Explain to your supervisor fully how you should calculate the discount rate (Hint: write out the formula for weighted average cost of capital/WACC). Include a full explanation of how you determined the cost of equity component of the WACC, as well as how to calculate it, and what it represents.