Capitalisation & discount rates in business valuations
In business valuations, capitalisation and discount rates are used to convert anticipated business incomes into business value estimates. Both capitalisation and discount rates are divisors applied to business income measures under the income-based valuation approach; however, the application methods differ.
Capitalisation rate is used to convert a single-period anticipated income into business value in the Capitalisation of Earnings method. Discount rate is used to convert future cash flows (an income stream) into present value (business value) in the Discounted Cash Flow method.
Capitalisation rate is normally applied to no-growth anticipated incomes, while discount rate is appropriate for income streams with both constant and varied growth projected. Generally speaking, if the anticipated income is not projected to grow, the discount rate would equal the capitalisation rate.
By Julia Podgorbunskaya, CPA, Senior Business Valuer at Professional Business Valuers
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