Discount Rate Recommendation for Proposed Investment
Dear, L. Scott Thompson,
Per your request, I have provided the following memo regarding Scotiabank’s potential new
division. The three rates of return for each sector include 11.61% (DDM – Historical Growth),
20.94% (DDM- Sustainable Growth), and lastly 10.98% (CAPM). The three weighted average
costs of capital (WACC) are 11.45% (DDM – Historical Growth), 20.65% (DDM – Sustainable
Growth), and 10.83% (CAPM).
The discount rate that I suggest we use in evaluating our proposed investment is 11.61%. Out of
the three estimates, this rate is the most conservative and correlates with the historical growth
rate. Given the uncertainty surrounding our entry into a new industry, the historical growth
rate provides a more accurate estimate, even though both the CAPM rate and the sustainable
growth rate are also excellent indicators.
This discount rate is appropriate since it reflects the expected return on investment that our
investors would need in a new business venture. A low discount rate could lead us to invest in a
project that doesn't generate enough return to justify the risk, while a high discount rate could
lead us to pass up a good investment opportunity.
Therefore, I believe 11.61% is the perfect discount rate for the proposed investment. I
appreciate your time and I hope my memo is useful for you and future investors.
Thank you