By: Bart Baesens, Seppe vanden Broucke
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You asked: What discount factor is commonly used in calculating Customer Lifetime Value (CLV)?
Our answer:
A common practice is to use the weighted average cost of capital (WACC) calculated as follows:
WACC = (E / (E+D)) * CE + (D / (E+D)) * CD(1 – t)
where E represents the (market) value of the equity, D the (market) value of the total debt, CE the cost of equity, CD the cost of debt and t the local tax rate. It represents the average cost of raising money which is invested in building and extending customer relationships. For many firms, this will range around 10%. Note that the WACC is usually expressed on a yearly basis, so when working with monthly time periods, the monthly discount factor becomes
(1 + WACC) ^ (-12) – 1
