Implied Discount rate - NABE

Forms of Payment and Discount Rate – Discount rateof revenue stream• Starting with a simple equality that holds every periodOperating Income = Revenue – Cost, where Cost = Fixed Costs + Variable Costs• Expressed in net present value terms over the relevant time horizon:where,NPV(Operating income, R OI ) = NPV(Revenue, R Rev ) – NPV(VC, R VC ) - NPV(FC,R FC )R OI = discount rate for Operating ProfitR Rev = discount rate for RevenueR VC = discount rate for Variable CostsR FC = discount rate for Fixed Costs• Finance literature suggest that revenue and variable costs have a high degree ofcovariance and thus they can be expected to have similar volatility/variability *• Thus, re-arranging terms:NPV(Operating income, R OI ) = NPV(Revenue - VC, R Rev ) - NPV(FC, R FC )* For example, see Brealey, R.A., and Myers, S.C; Principles of Corporate Finance 5th ed.; (1996) McGraw Hill Companies.20