Discount rate

Definition

The discount rate is the interest rate used to determine the present value of future cash flows. It reflects the time value of money and risk associated with those future cash flows.

5 Must Know Facts For Your Next Test

1. The discount rate is crucial for calculating the present value of a single lump-sum payment or an annuity.
2. A higher discount rate results in a lower present value for future cash flows.
3. It can be derived from various sources, including market interest rates and required rates of return.
4. In finance, it is often used to evaluate investment opportunities by comparing the present value of expected returns to initial costs.
5. The choice of discount rate can significantly affect financial decision-making and valuation.

Review Questions

• How does the discount rate affect the present value of future cash flows?
• What factors are considered when determining an appropriate discount rate?
• Why is the discount rate important in evaluating investment opportunities?

Related terms

Present Value (PV): The current worth of a future sum of money or stream of cash flows given a specified rate of return.

Future Value (FV): The value of a current asset at a specified date in the future based on an assumed rate of growth.

Annuity: A series of equal payments made at regular intervals over time.