Discount Rate What is it for?

  • Jul 26, 2021
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The discount rate it is the calculation that allows to know if a project will be profitable or not. Some experts point out the importance of making an adequate calculation of said rate, which can determine the minimum cost effectiveness acceptable expected in the project.

This is a financial indicator that is used to determine the value of money over time, plus specifically it is used to calculate the present value of some future capital and evaluate projects of investment.

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In this article you will find:

Interest rate versus discount rate

The interest rate is applied to an initial capital, to calculate its increase until reaching a final capital, this is recognized as capitalization. Secondly, the discount rate It comes to calculate the amount to subtract from a future capital, to obtain a capital in the present, this is recognized as an update.

So to understand, it is said that the discount rate determines the currency value of today, of money paid at some future time.

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For example, if a payment of $ 55 is promised in one year and the discount rate is 10%, the present value must be $ 50.

This calculation is important in the analysis of the cost and benefit shows the economic flows of a project produced at different times, in the monetary unit of the same year, in such a way that they can be comparable.

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Discount rate

Discount rate versions

There are different versions regarding this discount rate, they differ in turn by the elements they consider:

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  • Nominal: includes inflation.
  • Real: Does not include inflation.
  • Economic: It is a measure of the way in which society values ​​future consumption, in relation to current consumption. It focuses more on economic effects, rather than financial analysis.
  • Financial: It is applied to the analysis from the perspective of the private investor, it takes into consideration the cost of the credits or loans and the rates of return on alternative investments that could adhere to policies such as taxes and market failures that distort.

Variables to consider

To carry out an efficient calculation of the discount rate, some variables must be considered, such as:

  • Financing sources, either their own or from third parties.
  • Return without risk, provided by fluctuations in inflation and growth or decrease in GDP.
  • Risk premium, provided by the sensitivity of the average profitability of the market to enter and the forecast of the project's response to variations in said market.

Similarly, it is important that the project evaluator does not under-evaluate or over-evaluate. valuation of the values ​​of the net flows, so that the result of the calculation of the discount rate is right.

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Importance of the discount rate

The importance of this indicator lies in its own use in such a way that according to its use in economic policy it can have an impact dramatic in determining financial entities and private banks and other corporate investments that influence the movement of the economy.

From the investment point of view, businesses, companies or other economic entities should consider this measure to take decisions when dedicating their capital or part of it in the purchase of equipment, machinery or if in an additional dividend to the shareholders.

Depending on the additional benefit that shareholders will require in the future, it may be preferable to invest in the purchase of equipment, this is estimated with the discount rate. One way used to estimate this is by using stock price information, which is known as a fixed asset appraisal.

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