Methods for calculating the discount rate in business valuation. Discount rate - calculation, formula
Which is used when bringing future financial flows to their current value. Her calculation is perhaps one of the most relevant and difficult questions, which occurs when financial assessment any investment project. Its correctness determines what final value the current monetary value will have.
If apply low rate, then discounted value expected in the future cash receipts may be overstated. This will entail the choice of an inefficient project by the investor, as a result of which he will suffer serious losses. excessive high rate, in turn, can lead to losses that actually exist - a missed opportunity to generate income.
The discount rate, therefore, is the rate of return, in percent, that the investor must receive on the invested capital. That is, a project is considered attractive for an investor when the rate of return for him is higher than the discount rate of any other possible investment of capital with a similar risk.
The discount rate, on the other hand, is a reflection of risk and time, since the real money that a person has at the moment is much more preferable (they have a greater value) to an equal amount of money that he expects to receive in the future.
This is due to several reasons, such as:
- there is always a risk of simply not getting the estimated amount;
- the available amount could be profitable, say, being deposited in a bank.
- the available amount as a result of inflation will lose its purchasing power.
The discount rate includes the following parameters:
- investment risk ratio (for each specific case);
- the minimum level of return that can be guaranteed.
The discount rate, which is calculated on the basis of various methods, is often determined experimentally in practice. This takes into account both the requirements of the investor and investment bank, attracting the funds required.
IN Russian conditions is always associated with a variable level of risk, therefore, with constantly changing levels of income and expenses. For this reason, in practice, the profitability of a project is rarely calculated without taking into account the discount rate.
The method of discounting financial flows, which takes into account discounting, of course, reflects the existing value of income much more accurately.
The most common methods for determining the discount rate of financial capital flows include the following models:
1. For your own:
- valuation of capital assets;
- cumulative build.
2. For investment:
- weighted average cost of capital.
The fundamental point in the discounting process is the setting of a certain discount rate. From an economic point of view, the discount rate is the rate of return that could be obtained if the given funds were available to the organization. With the help, they determine the amount that the investor will have to pay today in order to be entitled to receive the estimated amount in the future.
The discount rate is required to:
- make a more accurate calculation of the profitability of the project;
- compare the obtained indicators of an existing project with the lowest rate of return when investing in a similar business.
What is a "discount factor"? How is the discount factor and discount rate calculated? Where and how is the discount factor applied?
In this article, we will try to define the concept of the discount factor and the procedure for calculating it.
Discount coefficient(“discount”) is an indicator that is used to bring the future price of money to their today's or current cost. In other words, this ratio allows the financier or investor to understand how the time factor will affect the value of the money invested in the investment project and future cash flows.
The discount factor is used to determine the present value. present value or PV ) in the following way:
future value Future value or FV ) * discount coefficient
The formula for calculating the discount factor
To determine the value of cash flows in the future, it is necessary to multiply each future cash flow by a discount factor, which is determined by the following formula:
k=1/ (1+i) n ,
k- discount coefficient,
i
n- the number of discount periods.
As can be seen from the formula, the discount factor is always less than one. It shows the cost of one monetary unit given for the current date.
The discount factor is also called " discount rate", although this is not entirely correct. Discount rate- this is the one interest rate, which is used to determine the discount rate The discount rate, in turn, depends on many factors. For example, on the magnitude and parameters of risks specific to the discounted object, such as inflation, credit risk, liquidity risk, etc. However, not all external factors that affect the economic efficiency of investments can be taken into account using the interest rate (for example, weather conditions or natural disasters).
The formula for calculating the discount rate:
i= r f+ R 1 +.. R n,
i– interest rate (“discount rate”),
r f- risk free rate
R1..Rn– expressed in percentage terms, adjustments for risk factors that affect the investment Money to a specific project (for example, specific risks specific to a particular company, industry or country).
Table of discount factors
There are several methods for calculating the discount factor, such as the cumulative method (adding risk-adjustments to the risk-free rate) or the expert method. However, the most common method is to calculate the discount factor using statistical tables. Since the size of the discount factor depends on two factors (time period and discount rate), the process of its calculation can be standardized and simplified using tables where the interest rate is indicated vertically and the time period is indicated horizontally. You can view and download to calculate the discount factor
Applying a discount factor
The discount factor is widely used in economics, business and financial analysis as a tool to bring future cash inflows to their present value for evaluation economic efficiency any business project or an entire enterprise. At the same time, the interest rate used to calculate this indicator and referred to as the "discount rate" is calculated separately for each individual case.
Sometimes the interest rate used to calculate the discount factor is refinancing rate or the key interest rate (which are now the same in Russia), the level , the average rate on loans or deposits in the economy, the minimum allowable level for the project, etc. Thus, the discount rate reflects the general level of risk of investments in a particular object.
For example, in accounting standards IFRS the discount factor is used to calculate:
- amortized cost of loans, investments and financial obligations carried at amortized cost,
- cost , being ,
- the value of reserves, defined as obligations with an indefinite maturity or obligations of an indefinite amount, in cases where the influence of the time factor on the value of money is significant,
- the value of obligations under pension plans and post-employment benefits,
- cost net investment in financial lease
- cost of inventories, fixed assets, intangible assets in the case of their acquisition on the terms of deferred payment.
IN investment analysis The discount factor is used in the discounted cash flow model. Discounted cash flow model ) to determine the intrinsic fair value investment assets. This model has the advantage of focusing on future cash flows and additional opportunity substantiation of the required return on investment. However, the disadvantage of this method is the inability to fully take into account the impact of current market conditions on the cost of the investment object (for example, the ratio of supply and demand in the market), and therefore these models are mainly used to assess the effectiveness of only long-term investments.
Everyone knows about deposits and calculation rules. Bank interest is added to the due amount and we get the amount of funds at the end of the period. For example, 1000 USD was put into the bank. under 20% per annum. Calculation of the total at the end of the year: 1000 divided by 100% and multiplied by 120% (100% + 20%). Everything is simple and clear.
However, how to determine how much you need to invest in order to get 1000 rubles. in a year. For this, a discount rate is used. The concept is used to assess the profitability of a business and long-term investment.
concept
"Discount" can be translated as a concession for paying in advance. Literally, it means bringing the economic indicator for a certain time period to a given interval. With absence economic education It is easy to get confused in such terminology. But a prudent owner should look into the matter, since most people do not suspect their participation in "discounting". For example, the merchant promises to sell the goods at a specified value in a year, when the ship arrives with the goods.
However, he needs financial resources to purchase goods that will participate in the exchange operation. There are two ways to get money: apply to a banker for a loan or take funds from future buyers. The merchant must plain language explain to the latter about the discount rate. If customers understand, then the success of the event will be ensured.
The discount rate is used for the following purposes:
- Calculation of business profitability. The investor must know the amount of profit in the future in order to invest funds with the desired return.
- Evaluation of the organization's activities. Available profit does not guarantee good profitability.
- Yield planning. The chosen investment option should have the maximum return compared to alternatives. For example, one business will have a certain profit in 1 year, while another will bring in more funds, but only after two years. Both proposals should be compared with the same denominator. For clarity, consider an example from practice. Two businessmen approached a potential investor. They ask to invest 2 million in their business. The first promises to return 3 million in two years, the second - 5 million in 6 years. How to calculate the discount rate when attracting borrowed capital?
Discounting in real life
Every Russian at least once thought about the "value of money." It is especially noticeable during shopping in supermarkets, when grocery basket You have to remove the "unnecessary" goods. At present, it is necessary to be economical and prudent. Discounting is often understood as economic indicator, showing the purchasing power of money, the value after a certain period of time. Discounting is used to predict profits for investment projects. Future results can be spoken at the beginning of the project or during its implementation when multiplied by the discount factor. But this concept is applicable not only to investments, but also in ordinary life. For example, parents want to pay for their child's education in a prestigious institution. But not everyone has the opportunity to pay a fee at the time of receipt. Then they start thinking about the “stash”, which is intended for the X hour. After 5 years, the child is scheduled to enter a European university. The cost of preparatory courses is 2500 USD. It is unrealistic for many to allocate such an amount from the family budget without prejudice to the interests of other members. Exit - open a deposit in advance financial institution. But how to determine the amount of the contribution in order to receive 2500 USD in five years? Deposit rate 10%. Calculation of the initial amount: 2500/(1+0.1)^5 = 1552 c.u. This is called discounting.
In simple terms, if you want to know the future value of a certain amount, then you should "discount" it at a bank rate, which is called the discount rate. In the given example, it is equal to 10%, 2500 c.u. - cash flow (payment amount) after 5 years, 1552 c.u. is the discounted value of the cash flow.
Discounting will be the reciprocal of investing. For example, when investing 100 thousand rubles at 10% per annum, the result is 110 thousand rubles: 100,000 * (100% + 10%) / 100%.
A simplified calculation of the final amount will help determine the return on investment. However, it is subject to adjustments.
When determining income for a couple of years, they resort to exponentiation. A common mistake is multiplying by total amount percent to account for "interest on interest". Such calculations are permissible in the absence of interest capitalization.
To determine the discount rate, you need to find the initial investment amount: multiply the final profit by 100%, and then divide by the amount of 100% increased by the rate. If investments go through several cycles, then the resulting figure is multiplied by their number.
In the international format, the English terms Future value and present value are used. In the example described, FV is 2500 USD, PV is 1552 USD. General form discounting:
PV = FV*1/(1+R)^n
1/(1+R)^n- discount factor;
R- interest rate;
n- the number of cycles.
The calculations are quite simple, not only bankers can perform them. But the calculations can be ignored if you understand the essence of the process.
Discounting- change in cash flow from the future to the present, i.e. the path of finance goes from the amount that is required to be received at a certain moment, to the amount that will be invested.
money + time
Consider another common situation: there are free funds that are decided to be deposited in the bank at interest. Amount - 2000 USD, interest rate - 10%. In a year, the depositor will already have 2200 USD at his disposal, since the interest on the deposit will amount to 200 USD.
If we bring all this to a general formula, then it will come out:
2000*(100%+10%)/100% = 2000*1.1 = 2200 c.u.
If we put 2000 c.u. for 2 years, then the total amount will be 2420 USD:
1 year 2000 * 1.1 \u003d 2200 c.u.
2 year 2200 * 1.1 \u003d 2420 c.u.
Extensions are available at no additional cost. If the investment period is extended, then the income will increase even more. For each course of keeping funds on deposit, the total amount of the deposit for the previous year is multiplied by (1+R) or the initial investment amount is multiplied by (1+R)^n.
Cumulative Method
To simplify the calculations, a table of coefficients is used. When it is applied, it is no longer necessary to calculate the amount of investment and profitability several times using the formula. It is enough to multiply the final profit by the coefficient from the table to get the desired investment.
The formula for determining the discount factor:
K \u003d 1 / (1 + Pr) \u003d B,
where IN- the number of cycles;
Etc- interest rate per cycle.
For example, for a two-year investment at 20%, the ratio is:
1*/(1+0,2)^2 = 0,694
Discount tables are similar to Brady's tables, which help students determine roots, cosines, and sines.
Discount factor tables simplify calculations. However, this method of calculation is not suitable for large investments. The given values are rounded to thousandths (3 digits after the decimal point), which leads to a large error when investing a million dollars.
Using the table is simple: if the rate and the number of periods are known, the desired coefficient is found at the intersection of the required columns and rows.
Practical use
Increasing the discount rate increases the payback period of the investment. The decision to invest funds should be made when the calculations show the desired payback period and are consistent with the capital investment plan.
A simplified calculation is made according to the formula for the return on investment period. It is based on the quotient between received and invested funds. The main disadvantage of the method is the assumption of a uniform income.
The above formulas do not take into account market risks. They can only be used for theoretical calculation. To bring the calculation closer to reality, they resort to graphical analysis. The graphs represent data on the movement of finance in a certain time interval.
Discounting and building up
Using a simple formula, determine the size of the contribution at the desired time point. Calculating the value of money in the future is called "build-up". The essence of this process is easy to understand by the expression "time is money" - over time, the size of the contribution increases by the increment of annual interest. All banking system based on this principle.
When discounting, the movement of calculations goes from the future to the present, and when “building up” - from the present to the future.
Discounting and building up help to analyze the possibility of changes in the cost of funds.
Investment projects
Discounting of funds is consistent with the investment motives of the business. That is, the investor invests and receives not human (qualified specialists, team) or technical resources (equipment, warehouses), but a flow of money in the future. The continuation of this thought will be "the product of any business is money." The discounting method is the only one of the existing ones, the orientation of which is aimed at development in the future, which allows the investment project to develop.
An example of choosing an investment project. The owner of the funds (600 rubles) was offered to invest them in the implementation of projects "A" and "B". The first option gives an income of 400 rubles for three years. Project "B" after the first two years of implementation will allow you to get 200 rubles, and after the third - 10,000 rubles. The investor has set a rate of 25%. Let's determine the current cost of both projects:
project "A" (400/(1+0.25)^1+400/(1+0.25)^2+400/(1+0.25)^3)-600 = (320+256+204 )-600 = 180 rubles
project "B" (200/(1+0.25)^1+200/(1+0.25)^2+1000/(1+0.25)^3)-600 = (160+128+512 )-600 = 200 rubles
Thus, the investor must choose the second project. However, if the rate is raised to 31%, both options will be equivalent.
Present value
Present value is the present value of a future cash flow or a future payment without a "discount" for an upfront payment. It is often referred to as the present value, the future cash flow relative to today. However, these are not exactly the same concepts. It is possible to bring to the current time not only one future value, but also the present value to the desired time in the future. Present value is more extensive than present value. IN English language there is no concept of present value.
Discount method
It was previously mentioned that discounting is a tool for predicting future profits - evaluating the effectiveness of the current project.
When evaluating a business, they take into account that part of the assets that can generate income in the future. Business owners take into account the time to generate income and the likely risks for profit. These factors are taken into account when assessing by the DCF method. It is based on the principle of "falling" value - money supply constantly "cheaper" and loses in value. The starting point will be the present value against which future cash flows are related. For this, the concept of the discount factor (K) was introduced, which helps to bring future flows to current ones. The main component of the DCF method is the discount rate. It determines the rate of return when investing in a business project. Various factors can be taken into account in the discount rate: inflation, the refinancing rate, the assessment of capital shares, the interest on the deposit, the return on risk-free assets.
It is believed that the investor should not finance the project if its cost becomes higher than the present value of the income in the future. Likewise, a business owner will not sell his assets for less than the price of future earnings. During negotiations, the two parties will come to a compromise in the form of an equivalent value on the day of the transaction of the projected assets.
An ideal investment option if the discount rate ( internal norm profit) more than the cost of finding funding for business ideas. This will allow you to earn like banks - the money will be accumulated according to reduced rate, and the contribution will happen - at the highest.
Additional calculations
The definition of the discount rate is inaccurate without analyzing some terms and concepts:
- The rate of return is the amount of investment at which the amount of net present value is 0.
- Net cash flow - costs are subtracted from total gross receipts. Direct and indirect costs (tax deductions, legal support) should be included here.
Only an expert can determine the exact value of a company's profitability, based on internal analysis companies.
Complicated calculations
In economics, a somewhat complicated calculation is used, which takes into account a number of risks. The formulas use the following concepts:
- Risk free, expected and market returns. Used in the Sharpe formula to determine economic risks.
- Sharpe's corrected model. Determines the influence of market factors: changes in the cost of resources, government policy, price fluctuations.
- The volume of investments, features of the industry. The data is used in a more accurate version of French and Fama.
- Changes in the value of an asset are used in Carhart's formula.
- Dividend payments and issue of shares. Similar calculations are due to Gordon. His method allows you to accurately study the stock market and analyze the value of joint-stock companies.
- Weighted average price. Apply before determining the discount rate in the cumulative method and accounting for borrowed funds.
- Profitability of the property. Used for analysis financial activities a company whose assets are not listed on the stock market.
- subjective factor. It is used in multifactorial analysis of the organization's activities by third-party experts.
- Market risks. It is taken into account when determining the discount rate based on the ratio of risky to riskless investment.
In 1997, the Russian government published its own methodology for calculating the risk discount rate. Experts of the time estimated the risks at 47%. This indicator is not used in the usual formulas, but it is mandatory when calculating investments in foreign projects.
Various calculation methods allow you to evaluate potential investments and build a plan for the allocation of funds. When analyzing the economic activity of companies in the market, theoretical calculations will give the expected effect if local realities are taken into account. Simple calculations will help predict returns, but they will be highly volatile. For forecasting, you need to use complex formulas that take into account most of the risks in the financial and stock markets. More accurate data will be obtained only through internal analysis of the company.
Calculations.
The size of the discount rate is influenced by the level, the degree characteristic of the object, the growth of funds over time, as well as others, which we will discuss in more detail below.
The purpose of the discount rate is to calculate the expected return (profitability) from the investment project as accurately as possible and to obtain a mathematical justification for the feasibility of certain financial investments.
How to calculate the discount rate
Most often, an ordinary investor is faced with a discount rate in cases where you need to figure out what price you can pay for shares (or others) that bring their owner some level of income (dividends) acceptable to the investor.
To make it clear what we are talking about, consider a simple example.
Let your friend be the owner of a share worth 1000 rubles, which at the end of each year “brings” him 250 rubles.
Obviously, the yield (as a percentage per annum) on this stock is 25%.
Let's also assume that you are considering investing your own savings in these stocks. At the same time, you will be satisfied with the yield within 20% per annum.
At what price would you be able to buy a share from your friend in order to achieve the required return by the end of the year?
To answer this question, you need to “discount” the current size of the stock at a rate of 20%, that is, make the following calculations:
250 rub. / 20% = 1250 rubles.
This means that by purchasing a share at a price of $1,250, you will be able to receive a dividend income of 250 rubles. (i.e. 20% per annum).
In this example, 20% is exactly the same discount rate(or, in other words, the minimum acceptable level of return for you).
With such calculations, you can bargain with a friend and buy a share at a price of 1000 to 1250 rubles.
Buying shares in this price range will have a return on investment of 20 percent (or more).
This is the most important subsection of the article, which has a clear practical focus. Re-read it a couple of times to catch and FEEL the logic of calculations. They contain the very essence of the concept of "discount rate".
Capital Asset Pricing Model (CAPM)
Capital Asset Pricing Model (CAPM) is used to explain the essence of the "risk-return" alternative as applied to investment.
It proceeds from the postulate that there is a clear relationship between the discount rate for specific investments and the measure of risk associated with the respective investments.
Inside the model is used formula for calculating the discount rate(in other words, the rates of return equity) of the following form:
I \u003d I n + β * (I m - I n), where
I- the size of the discount rate,
I n – the rate of return corresponding to a risk-free investment,
I m – average rate of return for a particular market segment,
(I m — I n) is the numerical value of the risk premium,
β - coefficient "beta", which characterizes the relationship between changes in stock prices of an individual company and the entire industry as a whole.
Market multiplier method
Market multiplier method uses as discount rates market multiples, representing various indicators of the level of earnings per share.
We are talking about the calculation of net income per share (ratio /P), earnings before interest, and depreciation charges, earnings before interest and taxes and earnings before taxes only.
Method for calculating the weighted average cost of capital
Already from the name of the method it is clear that the weighted average cost of capital (WACC) will be used as the discount rate in investment calculations.
This indicator is calculated by the formula:
WACC = [ I * E + J * D * (1 – T 0 )] / (E + D) , where
I is the rate of return on equity,
E- size market value share capital,
J- the value of the rate of return on borrowed capital,
D- the amount of the market value of borrowed capital,
T0- the absolute value of the income tax rate.
The disadvantage of the method is its inability to take into account the risks inherent in different types investment.
Cumulative construction method
Cumulative construction method is perhaps the most accurate method for calculating the discount rate.
The valuation is based on the sum of the so-called risk-free rate (sometimes referred to as the base rate) and premiums for different types risks: poor quality, industry, illiquidity of shares,.
The mathematical formula for calculating the discount rate using this method will be as follows:
I = I 0 + I 1 + I 2 + I 3 + I 4 , where
I– discount rate,
I 0 – risk free rate,
I 1 , I 2 , I 3 , I 4 – premiums for the risks mentioned above.
What determines the discount rate
The following factors have the greatest influence on the size of the discount rate (as the minimum level of return on investment):
REPUTATION of the company both in the stock market as a whole and in the eyes of private shareholders, openness and accessibility financial reporting for general knowledge.
This factor is difficult to quantify, but it is taken into account like no other in the process of forming the discount rate.
The degree of RISK specific to a particular industry. Discount rates for different sectors of the economy are individual.
The more stable the industry, the lower the discount rates for the respective stocks and the more willing they are by investors.
The impeccability of the history of the company shares of the enterprise. It reflects the ease of selling shares.
The easier and simpler it is to do this, the more attractive they are for investors and the lower the discount rate.
Discount Rate: Conclusion
So, we have considered the key concepts related to the concept of "discount rate":
- formulated discount rate determination,
- figured out What does the discount rate depend on?,
- reviewed the main discount rate calculation formulas,
- dealt with methods for determining the discount rate,
- considered a number of other important issues.
After reading the article, it will be useful to independently practice using the appropriate formulas, calculate the discount rate for some (even hypothetical) situations similar to those discussed in the article.
NPV = ∑ t = 0 NCF t (1 + i) t = − IC + ∑ t = 1 NCF t (1 + i) t (\displaystyle NPV=\sum _(t=0)^(N)(\frac (CF_(t))((1+i)^(t)))=-IC+\sum _(t=1)^(N)(\frac (CF_(t))((1+i)^( t)))),
where i (\displaystyle i)- discount rate.
The discount rate is a variable that depends on a number of factors i = f (i 1 , . . . , i n) (\displaystyle i=f(i_(1),...,i_(n))),
where (i 1 , . . . , i n) (\displaystyle (i_(1),...,i_(n)))- factors influencing future cash flows, which are determined individually for each investment project:
I 1 (\displaystyle i_(1))- the cost of an alternative investment in given period, be it: bet bank interest on deposits, refinancing rate, average profitability of an existing business, etc.;
I 2 (\displaystyle i_(2))- assessment of the inflation rate for the selected period, as an assessment of the cost of the risk of depreciation of funds for the period.
Discount rate calculation
The basis for predicting the discount rate is the theoretical premise of a close relationship between the yield of debt instruments (bonds) and equity instruments (shares). In general, an investor is willing to take on more risk (buy stocks) only if the expected return on them exceeds the return on the bond plus certain risk premiums. According to the model considered here, the future required rate of return by the investor is the sum of:
- Base rate for the issuer - the rate of predicted yield on currency (dollar) corporate bonds of this issuer (takes into account the premium for credit risk);
- Country risk premiums for equity holders (takes into account the risk of investing in equity instruments that is specific to Russian market stocks versus the bond market).
- Premiums for industry risks (takes into account the volatility of cash flows due to industry specifics);
- Premiums associated with the risk of poor corporate governance;
- Premiums for the risk of illiquidity of the issuer's shares.
In general, the formula for calculating the future discount rate can be written as follows:
I (\displaystyle i) = i b (\displaystyle i_(b)) + i s (\displaystyle i_(s)) + i o (\displaystyle i_(o)) + i k (\displaystyle i_(k)) + i l (\displaystyle i_(l))
Calculation of the base rate by issuer
The base rate is integral part discount rates. By your own meaning base rate shows at what minimum profitability market participants are ready to invest in a business. Contrary to popular belief, which considers the value of the base rate to be the same for all companies under consideration, the approach under consideration takes into account differences in business even at this initial stage. The base rate for each company is individual. This rate depends on the financial stability of a particular enterprise.
The financial strength of a company is determined either on the basis of a credit rating assigned to the issuer by independent rating agencies(S&P, Moody's, Fitch), or by analyzing its financial condition. Ideally, each company has its own base rate.
Thus, since the base rate takes into account the level of financial stability of the company, it really reflects the degree of risk (and, as a result, the minimum required return) that corresponds to investments in a particular company.
Calculation of the country risk premium (taking into account the specific risk of the host country)
Country risk is the risk of inadequate behavior of official authorities in relation to businesses operating in the country in question. The more predictable the attitude of the state towards business, the more the policy pursued by the state contributes to the development of enterprises, the lower the risks of doing business in such a country and, as a result, the lower the required profitability.
Country risk can be measured and expressed in terms of the additional return that investors will demand when investing in stocks or bonds of enterprises operating in the country in question.
In order to understand what is the additional yield that investors are now demanding to compensate for country risk, it is enough to compare the yields of government and corporate bonds. At the same time, to increase the accuracy of calculations, the compared bonds should have approximately the same level of liquidity, credit quality and duration. Thus, the difference in the yield of a basket of corporate and government bonds will be due only to the presence of country risk for investors investing in corporate bonds(for government bonds, the concept of country risk is not applicable).
The resulting difference in yields shows the amount of country risk for holders of debt instruments. For conversion this indicator when working with stocks, the calculated amount of country risk is multiplied by a correction factor determined by an expert.
Industry risk premium
This component of the discount rate is supranational in nature (that is, it does not depend on the country in which the business is conducted) and is determined solely by the internal feature of industries - the volatility of their cash flows. For example, the volatility of flows in retail and oil production will be completely different.
The most complete attitude of investors to the comparative measure of the risk of industries is expressed in developed stock markets. They are the source of calculation of industry premiums. For each industry of interest, a set of companies under study is determined, for which the average industry discount rate is calculated.
Objective grounds for an additional industry risk premium arise when the industry average discount rate (the investor's minimum yield requirement) exceeds the prevailing yield on US government bonds, the most reliable asset for an investor. Industries with average discount rates lower than US Treasury yields are considered relatively risk-free, that is, investors do not lay down additional specific requirements that increase the SD of issuers of these industries. For all other industries, the industry risk premium is calculated as the difference between the industry's average SD and US government bond yields. Accordingly, the calculated industry premium applies to all its issuers.
Premium for the risk of poor corporate governance (CG)
This premium reflects the risks of the owner of the issuer's shares, primarily related to the withdrawal of net profit and assets from the company.
Illiquidity premium
This premium arises due to the possible difficulties of the investor in acquiring or selling a block of shares without much loss in price and time. Other things being equal, an investor will buy a more liquid asset.