Managerial Accounting Chapter 13

Chapter 13
Managerial Accounting
Discount Rates
Prepared by Diane Tanner
University of North Florida
What is a Discount Rate?
 An interest rate
 Used to determine the cost of money over time
 Its use in managerial accounting decisions
 To determine how much future cash flow
amounts are worth in the present
 Two common discount rates
 Weighted average cost of capital
 Referred to as the 'cost of capital' or WACC
 Required rate of return (RRR)
 When assessing capital budget decisions
 Use the required rate of return
Cost of Capital
Assets are ‘financed’ by the two equities on the
right side of the accounting equation
Assets = Liabilities + Owners’ Equity
Debt Financing
Occurs when a company
 Obtains long-term
loans /bonds
Equity Financing
Occurs when a company
 Issues stock
 Earns profit which
increases net worth
Calculating the Cost of Capital
Assets = Liabilities + Owners’ Equity
Debt Financing
Equity Financing
Creates interest
expense which
reduces profit
Creates a cost consisting of
returns to investors
 Dividends
 Stock value growth thru
earnings retention
Managers weigh the two costs
based on the proportion of the
company that is financed by
Results in
debt and the proportion
financed by equity financing.
average cost
of capital
Required Rate of Return (RRR)
 Indicates the minimum amount—the hurdle—an
investment must meet in order to be accepted
 Also known as the hurdle rate
Required Rate
= average cost + Risk % + Inflation %
of Return
of capital
 Sometimes a % component for desired profit is added
The End