Day 1 on the CPA Canada CFE exam is focused on testing your understanding of strategic analysis and applying this technical knowledge on a single case. This case is based on Capstone 1, set a few years in the future, with a new set of strategic options to decide on. All of these strategic options will require a quantitative analysis, some of which you will need to apply a discount rate. But if the Day 1 exam has not provided you with a discount rate, what rate are you supposed to use? Here’s the answer.
Use Capstone 1 rate
If an updated discount rate is not provided on Day 1, you can use the Capstone 1 discount rate. When you do this, you must also add an assumption highlighting where you obtained this amount from (i.e. Capstone 1 case).
It’s not often that an updated rate in not given in Day 1, they usually provide you with a new rate. However, certain inputs, including the discount rate, may not be updated or reiterated in the case and this has happened in past CFEs. This shows the importance of thorough review of the Capstone 1 case before your exam.
Since you will have access to the Capstone 1 case during the exam, you are expected to reference important details from it. To streamline this process and save precious time during the exam, I recommend you create a cheat sheet containing essential information, with page numbers, for quick reference. This includes the discount rate used in Capstone 1. For example, in the NPF Capstone 1 case below, the discount rate was given in one of the Appendices and this can be re-used in the Day 1 exam if a new rate is not given.
Can you use another rate?
Some CPA solutions use the rate from the objectives as the discount rate. Rates from the Financial Statements, such as the bank interest rate, has also been used. These are also acceptable and can be used instead of the Capstone 1 rate. When you use any of these rates, make sure to state them in the assumptions.
Why do you need the discount rate?
There are several calculations that could require the use of a discount rate. Some of the more common assessments include:
- NPV: This is the most common quants tool where you use a discount rate. You would perform NPV when determining if a project will generate positive value or not. The NPV analysis involves discounting all future cash flows associated with a project or investment back to their present value using a discount rate.
- IRR: This is another important quants tool used in capital budgeting where you would use the discount rate. The Internal Rate of Return (IRR) is the discount rate that makes the NPV of all cash flows from a particular project equal to zero. In other words, it’s the expected annual rate of return that will be earned on a project or investment. You would calculate the IRR and compare to the discount rate. If the IRR exceeds the discount rate, the project is considered worthwhile as it is expected to generate a positive return. If the IRR is less than the discount rate, the project is likely to be rejected.
- Valuation: When valuing a company or a project, one method that can be used is the discounted cash flow (DCF) analysis. In this case, future cash flows are discounted back to their present value using a discount rate to determine the current worth of an asset or investment. However, Day 1 rarely requires a DCF valuation, most of the time it’s multiples based (eg, EBITDA x5).
Conclusion
In summary, when the discount rate for Day 1 is not given, use the Capstone 1 case discount rate, a rate from the Day 1 objectives, or the rate from another appendix (such as Financial Statements or another proposal). All of these methods are acceptable, just make sure you note it in your assumptions.
Extra resources
If you’re struggling with quants, the Day 1 Quants Mastery toolkit is a valuable resource to practice with.