Discount Rates and Scarcity of Capital

Dirk Schoenmaker and Willem Schramade
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Willem Schramade: Nyenrode Business University

Chapter 4 in Corporate Finance for Long-Term Value, 2023, pp 93-114 from Springer

Abstract: Abstract Dealing with the future and determining the present value of future cash flows are key parts of corporate finance. The first section of this chapter therefore addresses discount rates and the time value of money. Subsequently, the determinants of discount rates are discussed, starting with government bonds as a benchmark, and then adding the risk premia on corporate bonds and equity. This all applies to financial capital. Next, we introduce the social discount rate for social and environmental capital. The counterparty of companies’ social and environmental capital is the wider society, representing current and future generations. Leading economists argue for an equal treatment of current and future generations, which implies a low social discount rate. Finally, we show how the financial discount rate can be expanded to an integrated discount rate that can be applied to integrated value, which also includes social and environmental value. It is shown that larger environmental and social liabilities raise the integrated discount rate. Conversely, environmental and social assets lower the integrated discount rate.

Keywords: Annuity; Arbitrage; Bond; Bond market; Compounding; Credit rating; Discount factor; Discount rates; Discounted cash flow (DCF) model; Equity market; Integrated discount rate; Interest rate; Money market; One discount rate fits all heuristic; Opportunity cost of capital; Perpetuity; Policy rate; Present value of future cash flows; Social discount rate; Term spread; Time value of money; Yield (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/978-3-031-35009-2_4

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