Present Value refers to the current value of a business or asset established by converting future economic benefits to the present by applying a discount factor. It involves discounting future economic benefits to the present using an appropriate discount rate.
Where:
PV = Present Value
CF = Cash flows
r = Rate of Return
(1 + r) = Discount rate
The applicable discounting factor is the Weighted Average Cost of Capital (WACC) which is the discount rate which business valuators apply to convert future economic earning (cash flows) to the present value. 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 computed as the cost of debt plus the cost of equity where the cost of equity is computed as follows:
Cost of Equity = Rf + bx(MRP)
Where:
Rf = Risk-Free Rate
bx = Beta
(MRP) = Market Risk Premium
bx(MRP) = Equity Risk Premium