Intrinsic value and capiatlization rate

[Einstein]

Capitalization rate is used primarily in the RE industry where it is goes by Cap rate. In equity market unless you are talking about REIT it is discount rate.

It is the rate that represents your minimal acceptable return.

For instance lets say have two projects to work on A and B, A gives your 10% return and B gives your 15% return. Now each of these project has same payback period.

Now if you have decided that you will go with project A because it has higher return, you need money to execute it. Either now you might have your own money to use for this project, which might give you return say 5% if kept in bank or you might take a loan where you might be paying 8%.

So Cap rate or discount rate is the rate that represents best use of that money.

In public equity market use the term discount rate, the person you are referring is running HF in US so it might be okay for him to assume 4% as discount rate.

So if you find that a value for stock is 100 and its price is 70 so it is trading at 30% discount to its intrinsic value so you will buy it and hope that market becomes rational again and realize the true potential for that security and give you a chance to realize that gain.

Nice explanation there, I have a doubt here, for instance Marico industries's discount rate is getting low as they are raising capital from quite some time. does that means company is not using capital properly??

 

[roketsingh]

I might not be able to provide the explanation that you are looking for but I will try. Also, before we go into numbers I would request you to please provide me some numbers or links if you have some handy. ( I can do internet search but what if we don't hit the same results)

Discount rate is the function of cost of debt and cost of equity ( I am talking about FCFF)

If we take simple example then it is

WACC = (Rd*D +Re*E)/(D+E)

I am ignoring taxes, transaction cost and cost of default at the moment.

Historically Rd has been a cheaper source of capital so companies tend to increase D and your overall WACC goes down accordingly. However, after certain point, debt holders will realize that company is putting too much debt and hence would start demanding higher premium because they will think that company might not be able to service its debt.

As long as Marico industries (again I dont have any numbers) keeps its debt below a threshold it will be able to reduce its WACC/Discount rate.

 

[Einstein]

Try this linkl:
http://www.marico.com/html/investor/annual-report-2003-2004.html

 

[Mr.G]

Einstein ROCE and discount rate are two different things, stop making a public mockery out of yourself.

Discount rate : http://www.investopedia.com/terms/d/discountrate.asp

What your talking about: http://www.investopedia.com/terms/r/roce.asp

Now singh ji confusing WACC with discount rate. Stop spreading wrong information people!

 

[roketsingh]

Mr G-- Know-it-all


what rate would you use to discount your cash flows to the firm?

 

[Einstein]

G sir, I already told you they are not same thing, but they are similar in a way.. there is a relationship.. i was just clarifying my doubt with roketsingh, B'coz there is no shame in clarifying doubt rather then losing real money. if you have problem with that then fine i keep quite.

Just to add there i'll be buying marico within this week or next.

 

[roketsingh]

Eins I sent you a PM.

 

[Mr.G]

I am getting confused. How can discount rate be similar to ROCE?!

Discount rate is used in valuation models to factor in time value of money.

If I am making any mistake and there is relationship between the two, of which I have never seen in my study of investing than please show me any publication which can help me understand it. Or explain it yourself.

Looking forward to a healthy and informative debate on this subject.

 

[roketsingh]

I am getting confused. How can discount rate be similar to ROCE?!

Discount rate is used in valuation models to factor in time value of money.

If I am making any mistake and there is relationship between the two, of which I have never seen in my study of investing than please show me any publication which can help me understand it. Or explain it yourself.

Looking forward to a healthy and informative debate on this subject.

Mr G you have not answered my question yet. Also to start a healthy conversation you need to change your attitude.

First you accuse people of spreading wrong information when your fundamentals are not clear. You are just a novice in this world in many respects. If I am commenting on your posts with decency then it does not mean that I cant reply with nasty comments or rip you apart.

You are trying to establish yourself in this industry so please be nice and humble. Literately you are like nobody in this industry right now.

 

[Mr.G]

Mr G you have not answered my question yet. Also to start a healthy conversation you need to change your attitude.

First you accuse people of spreading wrong information when your fundamentals are not clear. You are just a novice in this world in many respects. If I am commenting on your posts with decency then it does not mean that I cant reply with nasty comments or rip you apart.

You are trying to establish yourself in this industry so please be nice and humble. Literately you are like nobody in this industry right now.

I understand,Thank you for pointing out that my fundamentals are weak. And that you can also give nasty comments and rip me apart.

I am a nobody in this industry that is very true.

You please continue. I have no further wish to correspond with you. :thumb: