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Black's Simple Discounting Rule

42 Pages Posted: 17 Mar 2008 Last revised: 27 Jan 2013

Claudio F. Loderer

University of Berne - Institute for Financial Management; European Corporate Governance Institute (ECGI)

John B. Long Jr.

Simon Graduate School of Business, University of Rochester

Lukas Roth

University of Alberta - Department of Finance and Statistical Analysis

Date Written: August 21, 2008

Abstract

We study the implementability of Black's (1988) elegant discounting rule. The rule overcomes thorny problems that traditional valuation approaches struggle with, namely identifying the market portfolio, measuring project risk, and assessing the market risk premium. We offer new theory, showing that the conditional mean cash flow called for in Black's rule equals a given percentile of the cash flow distribution. Moreover, we present evidence that the probability level of the percentile in question is reasonably stationary in time and across countries, and that managers typically have the information our implementation requires. Computing project and firm value with the approach we are proposing is a feasible and theoretically sound alternative to other valuation methods.

Keywords: Black, valuation, discounting, conditional cash flows

JEL Classification: G12, G31

Suggested Citation

Loderer, Claudio F. and Long, John B. and Roth, Lukas, Black's Simple Discounting Rule (August 21, 2008). Simon School Working Paper No. FR 08-25. Available at SSRN: https://ssrn.com/abstract=1135276 or http://dx.doi.org/10.2139/ssrn.1135276

Claudio F. Loderer (Contact Author)

University of Berne - Institute for Financial Management ( email )

Engehaldenstrasse 4
Bern, CH-3012
Switzerland
+41 31 631 37 75 (Phone)
+41 31 631 84 21 (Fax)

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

John B. Long Jr.

Simon Graduate School of Business, University of Rochester ( email )

Carol Simon Hall 3-208
Rochester, NY 14627
United States
585-275-3358 (Phone)

Lukas Roth

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32E Business Building
Edmonton, Alberta T6G 2R6
Canada
780-492-4431 (Phone)
780-492-3325 (Fax)

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