Discount Rate: Definition, Formula, and Calculation

Why is the Discount Rate So Important?

It is the most sensitive parameter in a DCF valuation. A 1% change can modify the company value by15 to 25%. For a €5M-valued SME, this represents €750k to €1.25M difference - the difference between a good deal and a bad one.

This is why the choice of discount rate is often the first negotiating point between buyer and seller in a transaction.

The WACC Formula

The WACC combines the cost of equity and cost of debt, weighted by their respective share in company financing:

WACC = (E / V) × Ke + (D / V) × Kd × (1 − t)

• E = value of equity
• D = value of financial debt
• V = E + D (total value of capital)
• Ke = cost of equity
• Kd = cost of debt (average interest rate)
• t = tax rate (20-25% depending on jurisdiction)

The term (1 − t) reflects the tax deductibility of interest: debt costs less after tax, creating an advantage to partially finance the company through borrowing.

How to Calculate Cost of Equity (Ke)?

Cost of equity is estimated using the CAPM model (Capital Asset Pricing Model):

Ke = Rf + β × (Rm − Rf) + company-specific premiums

• Rf = risk-free rate. For European companies, typically the 10-year government bond yield, currently around 3.35%.
• β (beta) = company sensitivity to market fluctuations. A beta of 1 means the company moves with the market. SMEs typically have a beta between 0.8 and 1.5 depending on sector.
• Rm − Rf = equity risk premium (ERP). In developed markets, estimated at5.0 to 5.5% (source: Damodaran 2025-2026).
• SME-specific premiums = additional premiums for size (illiquidity), key person dependency, customer concentration. They typically add 2 to 5% for a private SME.

Example Calculation for an Industrial SME

Consider an industrial SME with the following characteristics:

This 9.1% WACC is at the lower end of the range for an industrial SME. A rate between 10% and 13% is more typical for most SMEs.

WACC Benchmarks by Sector

The complete table of sector WACCs is available on ValorPME. As an indication, the ranges observed in 2025-2026:

Common Discount Rate Mistakes

1. Using a rate that is too low - Applying 8% WACC to an SME heavily dependent on its founder is like valuing it as a large listed company. The SME risk premium must be included.
2. Confusing nominal and real rates - DCF works with nominal cash flows (including inflation). The discount rate must therefore also be nominal, not real.
3. Ignoring target capital structure - WACC is calculated based on target capital structure (long-term), not current structure. If the company is temporarily over-leveraged, the target structure may be very different.
4. Not testing sensitivity - Always vary WACC by ±1% and ±2% to measure the impact on valuation. This is the key tool for establishing a negotiation range.

Discount Rate in ValorPME

ValorPME automatically calculates WACC based on your industry, company revenue (as a size proxy), and Damodaran 2025-2026 benchmarks. The model incorporates log-linear interpolation to adapt beta to SME size and generates a sensitivity matrix showing the impact of ±1% and ±2% on the final valuation.

You can also input your own WACC if you have a professional estimate or wish to test different scenarios. To understand how terminal value interacts with the discount rate in the model, consult our dedicated guide. Launch a free simulation →