From the course: Finance Foundations: Business Valuation
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Risk and interest rates
From the course: Finance Foundations: Business Valuation
Risk and interest rates
- Why are you willing to accept a 0.1% return on your savings account at the bank? Because it's safe. You don't have to worry about whether you're going to get your money back, so you accept the low return. But if you invest in our friend's online retailing business will you accept an expected return of 0.1%? No, certainly not. With the investment in our friend's business, there is a chance that you will make a lot of money, but also a chance that you will lose everything. That is risk, variability in potential future outcomes. When valuing the cash flows expected to come from a business we use a higher interest rate to compute the present value of very risky future cash flows Interest rates to value the future cash flows of large companies can be between 5% and 15%. For small startup companies, like our friend's online retailing business, the increased risk involves, meaning the appropriate interest rate is higher, 15 to 25%…
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