Adjusting the Discount Rate to Alternative Economic Income Measures

Abstract

In some situations, analysts may desire to discount returns to some other economic income measure, such as pretax cash flows, net income, earnings before interest and taxes (EBIT), or earnings before interest, taxes, depreciation, and amortization (EBITDA). The principle in any conversion is that the present value of the alternative income measure discounted at an appropriate discount rate should equal the present value of net cash flows discounted at an after-tax discount rate. The after-tax capitalization rates can be converted to net income or pretax cash flow capitalization rates, and even to net income or pretax discount rates, provided that we assume zero or constant growth. Conversion of after-tax rates with changing growths is also discussed in this chapter.