Topic 3 – Determination of Equity Discount Rate Ke

ISSUE 3– DATE 19 JULY 2015

1. INTRODUCTION AND OBJECTIVE

This article attempts to discuss on some basic principles that should be considered when determining the cost of equity, which is the discount rate used when using the FCFE method (discussed in Topic 2). There are a few methods that can be used to determine the cost of equity, and this article shall attempt to discuss the potential pros and cons of the various methods.

Method Explanation
Free Cash Flow to Equity (FCFE)

FCFE derives the equity value attributable to the equity project sponsors.

The Internal Rate of Return (IRR), as determined using the net cash flow from FCFE is known as the equity IRR.

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THANKS FOR READING.

This article is prepared by Ong Tee Chin, CFA, FRM, and represents the view of the author. He can be contacted at ong@atlantiscapital.org for any further enquiries on the contents of this article.

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CERTIFICATION

Chartered Financial Analyst
CFA Institute



Financial Risk Manager
Global Association of Risk Professionals (GARP)

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