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 = [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 ([math]t[/math])

If the future value after one year is $10,500 and the discount rate is 5% then:

- Present value = [math]\frac{10,500}{(1.05)^{1}}[/math]

**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 = [math]\frac{2,500}{(1.07)^{2}}[/math]

**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.

## See Also

## References

- ↑ R. A. Brealey et al.
*Fundamentals of Corporate Finance*. Toronto: McGraw-Hill Ryerson, 2012, pp. 85.
- ↑ "Routledge Dictionary of Economics", discount rate, published Routledge Press, 2013. Edited by Donald Rutherford Online version accessed [August 17th, 2017].