If you want to understand discounting many confuse his rate with the coefficient.
The discount rate is a derivative based on which coefficients are calculated.
That is, in order to make discounting, you must first calculate (determine) the discount rate, and then on its basis the coefficient itself, with the help of which, according to the planned periods, the future value of money is reduced to the current one (i.e. discounting).
Usually the rate is calculated once, and the coefficient for each forecast period.
The discount rate is calculated by summing up all the risks for the assessed event.
For example.
Entrepreneur Petya invests a certain amount of money in rubles in some project, and he also plans to get a return on them in rubles.
He estimates that the value of his money in the future, which he will receive as a return on today's investments, will be influenced by:
- Ir - inflation per ruble (12% per year)
- RCP – Price reduction risk (3% per year)
- RCC – risk of rising commodity prices (2% per year)
- Rop – the risk of a decrease in the physical volume of sales of its products (2% per year)
- etc.
Thus, the average annual discount rate for entrepreneur Petya on the value of the ruble in this case will be:
Sd = Ir + Rcp + Rcs + Rop = 12 + 3 + 2 + 2 = 19 %
Based on the value of this particular rate, when calculating his business plan and assessing real cash flows, the decision he makes will be based on the feasibility of implementing the project from the point of view of its commercial efficiency.
Cash flows should be discounted using discount coefficients calculated on the basis of this rate (in this case, 19% in rubles).
If the cash flow is planned to a greater extent in dollar equivalent, then it is necessary to proceed from the risks of this nominal currency. Well, for example, the average annual inflation for the US dollar is 7% today (and 12% for the ruble). Other risks regarding this currency are placed in the rate purely at the discretion of the investor developing a business plan.
Thus, the discount rate will be calculated for each project individually on the basis of risks and their values (determined by the investor himself), taking into account various factors that can affect the amount of real economic return.
The discount rate – what is it: the difference from the coefficient – Something like that!
