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Why is discount rate 12%?

Caribbean Island – MBB Final Round
New answer on Apr 28, 2023
2 Answers
920 Views
Zhide
Premium
Skilled
asked on Apr 27, 2023

I understood practically everything except for how the discount rate 12% is derived… (oh no). How can we calculate it and did I miss information on that in the case?  Many thanks :)

 

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Francesco
Expert
Content Creator
replied on Apr 28, 2023
#1 Coach for Sessions (4.500+) | 1.500+ 5-Star Reviews | Proven Success (➡ interviewoffers.com) | Ex BCG | 10Y+ Coaching

Hi Tian,

Q: How can we calculate it and did I miss information on that in the case?

The discount rate in a DCF model is the rate of return used to discount the future cash flow. It is normally approximated with the Weighted Average Cost of Capital (WACC) of a company, which implies that, assuming the market is efficient, the more risky the investment, the higher the discount rate.

In a case interview normally it is either given (in this case they mentioned it was 12%) or you can ask if you can approximate to 5% or 10% for simplicity. 

 

For a more technical analysis, you can check this:

▶ How to Find the Net Present Value of a Company

Best,

Francesco

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Zhide on Apr 28, 2023

Dear Francesco, Thank you for the prompt reply. In this case then it means that I would get a discount rate 12% if I were to ask my interviewer instead of setting it myself? And I should also assume that this 12% is for the ease of calculation when the candidate also takes the growth rate into consideration? Best, Tian

Francesco on Apr 28, 2023

Hi Tian, that’s correct, in this case the interviewer should provide that. I believe the case uses 12% because the growth rate is 2%, so this makes the DCF calculation easier as the denominator of the perpetuity becomes 10%

Ian
Expert
Content Creator
replied on Apr 28, 2023
#1 BCG coach | MBB | Tier 2 | Digital, Tech, Platinion | 100% personal success rate (8/8) | 95% candidate success rate

Hey Tian,

Don't worry too much about this - you are ok here! You didn't miss anything :)

In almost every case the discount rate will be told to you. Most often it will be 10%. Sometimes it will be 5 or 15 (and 12% is odd, but not a “problem”)

Discount rate is basically “what return can we get from our money if we invested it elsehwere”. This is different per firm/case but Cost of capital, cost of equity, IRR, interest rate, etc. are all options.

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Zhide on Apr 28, 2023

Dear Ian, many thanks for the quick answer! Will drill on the discount rate topic :) Have a nice day. Best, Tian

Ian on Apr 28, 2023

My pleasure Tian! Have a great day as well!

Francesco gave the best answer

Francesco

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