What is a Discount Rate?

Why the Discount Rate Is the Most Important DCF Input

The discount rate is often called the "gravity" of valuation: the higher it is, the more it pulls future cash flows down toward zero in present-value terms. A business that looks cheap at a 10% discount rate may look fairly valued or expensive at 12%. This sensitivity is why analysts always stress-test their models across a range of discount rates and why Buffett prefers simple, predictable businesses where cash flow uncertainty -- and therefore discount-rate uncertainty -- is low.

The WACC is the theoretically correct discount rate for free cash flow to the firm. It requires estimating the cost of equity (usually via CAPM), the after-tax cost of debt, and the target capital structure weights. Each of those inputs carries its own assumptions, so many practitioners prefer a simpler approach: use a flat 10% rate as a minimum acceptable return and add a risk premium for smaller or less predictable companies.