DISCOUNT RATE:
The discount rate used in the present value models is the investor’s required rate of the security in which investment is proposed to be made. The time value of money is represented by the risk free interest rate such as those on government securities. A premium is added to this risk free interest rate to take care of the risk to be borne by the investor by the risk premium that the investor will require. The assessment of risk and the estimation of risk premium required are usually done by investors on a subjective bases. Though other objective methods are available for the purpose, they are not popularly used. Thus, the investor’s required rate of return would comprise the risk free interest rate plus premium.
The present value models discussed above are also known as dividend discounted valuation models because they discount the stream of dividends expected to be received from a share in the future.
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