Choosing the optimal discount rate is a task that requires taking into account information regarding both the company’s properties and external data. An employer should consider several factors relating to the business when setting the discount rate. In this case, the company’s financial stability is determined by characteristics that include the type and scale of the firm’s business and the environment in which it functions. In this regard, each enterprise needs to consider its credit rating and assess its revenue potential to calculate its discount rating correctly. It is also relevant to consider the peculiarities of the economic system of the country where the business operates (Schroeder et al., 2022). In addition, an essential factor in this regard is the inflation rate, as it directly affects the economic conditions. Thus, the optimal discount rate will be higher in financially unstable companies or those located in countries with challenging business conditions.
The crucial information in determining the discount rate is the riskiness of the business and the possibility of access to capital. In this case, a vital factor in appropriately assessing the company’s business potential and possible future revenues. The volatility of financial flows in enterprises of different types and directions may significantly differ, which affects the choice of a rational discount rating (Schroeder et al., 2022). Thus, companies with significant assets and access to them can set the discount rate at a low value compared to small companies. Consequently, it is rational for enterprises at the initial stage of development to set a high level of discounting due to the lack of guarantees of return on their activities. Therefore, the company’s stability and ability to manage capital are essential factors in selecting a discount rate. Overall, a proper assessment of the company’s properties, the economic environment, correct revenue estimates, and business risk characteristics allows the employer to choose a reasonable discount rate.
Reference
Schroeder R. G., Clark M. W., & Cathey J. M. (2022). Financial accounting theory and analysis: Text and cases. Wiley.