Question

Smith Inc. is a public company but is tightly controlled by Joe Smith. Mr. Smith is quite confident about his ability to evaluate investments in all aspects of the business. The situation at Smith Inc. is quite different from that at Jones Inc., although they share a similar line of business. Jones Inc. has a much less powerful CEO, Fred Jones, who delegates much more control to the firm’s divisional heads. Mr. Fred meets with the divisional heads to make a capital allocation choices as a group.

Discuss how and why Smith Inc. and Jones Inc. might have different approaches for determining the discount rates used to evaluate their projects.

Answer 1

discount rate is the rate which used to determine the present value of any futer cash flow for making finacial decision .

there are diffrent methods to determine the discount rate to determine the present value of future expected cash flow .but most commonly are WAAC-weighted average cost of capital and opportunity cost .individual investor consider opportunity cost for discount rate - opportunity cost is the rate of return which can be earn by the investor in the market,

corporate often use WAAC for selection of discount rate , WAAC is the weighted average cost of capital of various financing resources because firm use various resources for financinf and the INTEREST RATE IS DIFFRENT FOR EVERY SOURCE OF FINANCE . so WAAC gives the average rate of cost of financing .

Smith inc. and jones inc. might use diffrent methods for deciding the discount rate to evaluate their project . smith is powerful in CEO he might be use WAAC criteria to decide the discount rate for calculating the present value for their project and jones is not very powerful ceo so he might not be take appropriate discount rate for evaluating their project.