How Do Investors Compute the Discount Rate? They Use the CAPM (Corrected June 2017)

Jonathan B. Berk and Jules H. van Binsbergen

Financial Analysts Journal, 2017, vol. 73, issue 2, 25-32

Abstract: We provide guidance to corporate managers and investors on how to select the discount rate when evaluating investment opportunities. When making corporate investment decisions on behalf of the equity investors in a firm, an obvious choice is to use the method that equity investors use in making their own investment decisions. We infer how investors compute the discount rate by looking at mutual fund investors’ capital allocation decisions. We find that investors adjust for risk by using the beta of the capital asset pricing model (CAPM). Extensions to the CAPM perform poorly, implying that investors do not use these models to compute discount rates. Disclosure: The authors report no conflicts of interest. This article is an updated version of the version that was posted on 26 September 2016. Editor’s Note: The original version had a production error in Table 2, which has been corrected in this version.Submitted 3 November 2015Accepted 31 May 2016 by Stephen J. Brown

Date: 2017
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DOI: 10.2469/faj.v73.n2.6

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