In capital budgeting, the discount rate to use in net present value (NPV) calculation is a critical factor that influences the project’s feasibility. It represents the opportunity cost of capital, which is the return that could be earned by investing in an alternative project with similar risk.
The discount rate is typically based on the weighted average cost of capital (WACC), which considers both debt and equity financing. It is important to select the appropriate discount rate based on the project’s industry, risk level, and financing structure. Historically, the discount rate was often determined by intuition or rule of thumb, but today, sophisticated financial models are used to calculate it more accurately.