The Discount Rate is a rate of return used to convert future economic benefits (cash flows) to a present value. One of such rates is the Weighted Average Cost of Capital (WACC), a discount rate which incorporates the capital structure and used to discount future cash flows to determine the fair market value of a business entity. It involves the assignment of weights to equity and debt, based on the capital structure of the business entity, for the determination of the cost of all financing sources in the business enterprise's capital mix. The WACC is most applicable in the use of the discounted cash flow method of business valuation. When the WACC is applied to convert future cash flows to the present, the result is the fair market value of the business entity. The WACC is computed as the cost of debt plus the cost of equity where the cost of equity is computed as:
Cost of Equity = Rf + bx(MRP)
Where:
Rf = Risk-Free Rate
bx = Beta
(MRP) = Market Risk Premium
bx(MRP) = Equity Risk Premium