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Why 15%? That is a large discount rate on these blue choppers...

Hi Matt,

Ah, the joys of picking a discount rate. :-)

I definitely do not like the CAPM way of building cost of capital (at least the part using beta to adjust cost of equity). Even if you use some multiplier other than beta (the "classic" beta being the variability relative to some benchmark, usually the S&P 500; other "beta" multipliers can be used, such as country risk multiplier or currency risk multiplier, and more than one can be used, too), even with that, there's also the issue with determining an appropriate risk-free rate. 10-year Treasuries are really low, historical risk-free rates don't seem to apply, etc. Then there's adjusting up or down based on whether or not it's a blue chip or a macro cap or a high growth or whatever, which feels very subjective to me.

At the risk of keeping it too simple, I prefer to use a discount rate representing the average rate of return I want to see from an investment. 10% or 11% would be the market's average long-term return, while 12% would beat that. I want to do better, so I use a higher (and usually constant across companies) discount rate, one that doubles my money every five years (discount rate being the backwards way of looking at a growth rate).

So it boils down to the following: If the company grows as modeled, an investment at that price should return 15% per year on average. If it grows faster (that is for the MUE Port idea, if it grows FCF faster than modeled), the expected return would be higher.

Plus, this has the advantage of buffering against those that flame out and where I lose on the investment.

Simplistic, maybe, but there you are.

Cheers,
Jim
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