The rate at which future cash flows and terminal value is discounted is known as Discount Rate. If it is FCFF model then the Discount rate us Cost of Capital (Also known WACC) and if it is FCFE model then the discount rate is Cost of Equity:
Cost of Capital (WACC, Ko): Minimum required rate of return of all investors in the Firm (Includes Debt, common Equity and Preferred Equity)
Formula for WACC calculation:
WACC = Ke*We + Kd*(1-Tax rate)*Wd + KPs*WPs
Where Ke = Cost of equity and We = weight of equity
Kd = Cost of debt and Wd = weight of debt
KPs = Cost of Preferred equity and WPs = Weight of Preferred equity
Cost of Equity (Ke): Minimum Required rate of return of common equity
Formula: Rf + Beta * (Rm – Rf)
Where Rf represents Risk Free rate
Rm represents Market Return
Beta: Beta shows the riskiness of the stock with respect to all market index.
If Beta is 2, then it shows that if market goes up by 10% then individual stock will go up by 20% and market goes down by 10% then individual stock will go down by 20%.
Risk Free Rate:
Risk Premium (Rm-Rf): Risk Premium is generally an assumption of analyst. But sometimes, Risk Premium is taken from Historical returnsalso which is not recommended because WACC will be used to discount future cash flows and so we have to think of minimum expected return in future.
Many times Beta is directly taken from Bloomberg or some other sources, but that beta is historical beta and may be manipulated also and may not reflect the true riskiness of stock and if it is private company then Beta will not be available at all.
So in all these cases, it is suggested to recalculate beta based of Industry average fundamental
Cost of Preferred Stock (KPs): Minimum Required rate of return of preferred equity. Cost of preferred stock is Dividend Rate on Preferred Stock.