Discount rate: Difference between revisions
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<onlyinclude>The discount rate is the interest rate that firms use to determine how much a future cash flow is worth in the present.</onlyinclude> The practice of using the discount rate to evaluate cash flows is called [[discounting]]<ref>R. A. Brealey et al. ''Fundamentals of Corporate Finance''. Toronto: McGraw-Hill Ryerson, 2012, pp. 85.</ref><ref> | <onlyinclude>The discount rate is the interest rate that firms use to determine how much a future cash flow is worth in the present.</onlyinclude> The practice of using the discount rate to evaluate cash flows is called [[discounting]]<ref>R. A. Brealey et al. ''Fundamentals of Corporate Finance''. Toronto: McGraw-Hill Ryerson, 2012, pp. 85.</ref><ref name=Rout_econ>"Routledge Dictionary of Economics", discount rate, published Routledge Press, 2013. Edited by Donald Rutherford Online version accessed [August 17th, 2017].</ref> | ||
Using the discount rate, the calculation finds the '''present value''': | Using the discount rate, the calculation finds the '''present value''': | ||
::::::::Present value = < | ::::::::Present value = <math>\frac{Future\ Value\ After\ t\ Periods}{(1+r)^{t}}</math> | ||
::::::::* | ::::::::*<math>t</math> = Period of time measured in years | ||
::::::::* | ::::::::*<math>r</math> = The discount rate (interest rate) expressed as a decimal | ||
::::::::*The future value after the whole period of time ( | ::::::::*The future value after the whole period of time (<math>t</math>) | ||
If the future value after one year is $10,500 and the discount rate is 5% then: | If the future value after one year is $10,500 and the discount rate is 5% then: | ||
::::::::::::Present value = < | ::::::::::::Present value = <math>\frac{10,500}{(1.05)^{1}}</math> | ||
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If a consumer wants to save their money to earn interest so they can buy a new TV in 2 years, then they can use the price of the TV ($2,500, assuming it does not change) and find out how much money they need to save at 7% interest: | If a consumer wants to save their money to earn interest so they can buy a new TV in 2 years, then they can use the price of the TV ($2,500, assuming it does not change) and find out how much money they need to save at 7% interest: | ||
::::::::::::Present value = < | ::::::::::::Present value = <math>\frac{2,500}{(1.07)^{2}}</math> | ||
Revision as of 20:38, 17 August 2017
The discount rate is the interest rate that firms use to determine how much a future cash flow is worth in the present. The practice of using the discount rate to evaluate cash flows is called discounting[1][2]
Using the discount rate, the calculation finds the present value:
- Present value =
- = Period of time measured in years
- = The discount rate (interest rate) expressed as a decimal
- The future value after the whole period of time ()
If the future value after one year is $10,500 and the discount rate is 5% then:
- Present value =
- Present value = $10,000
If a consumer wants to save their money to earn interest so they can buy a new TV in 2 years, then they can use the price of the TV ($2,500, assuming it does not change) and find out how much money they need to save at 7% interest:
- Present value =
- Present value = $2,183.59
If they put $2,183.59 away at 7% interest over 2 years then they will have the right amount of money to buy the TV they want.