Discounting cash flows

CFA Level II Corporate Finance
#1

Hello guys,

I would like to pick your brains on discounting concept. Assuming we are discounting cash flows over a 5 year period using a discount factor, are we supposed to adjust the discount factor with growth assumption when growth has already been factored in the cash flows (adjusting both rate and cash flow) or we only adjust the cash flows?

Also, in deciding what risk free rate to use as a discount factor, which one would be preferable, a yield on a 91 day treasury bill or a 364 day treasury bill (assuming we have decided to use treasury bill yield as discount factor)? And to throw a spanner into the whole thing, assuming we are doing the analysis as at 31.12.2018 and the treasury has issued new treasury notes (say in February 2019) of 2 years and 3 years with yields of 17% and 14%, respectively, can we used the yields on these subsequently issued instruments for our analysis as at 31.12.18

#2

Hello, you should adjust the cash flows for growth the discount factor is related to the risk implied in thus cash flows so you don’t have to adjust the discount factor for the growth rate cause the uncertainty in the forecasting (growth rate) is implied in the discount factor (actually in the discount rate).

regarding your q about risk free, I think the best way to do it is to match the cash flow timing with the T-bill or T-bond maturity, so you’ll pick as risk free the YTM of the bond (T-bill or T-bond) that better match the timing of the cash flow that you’re discounting

#3

Thank you very much. This is very helpful.