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Discounting


Discounting calculates the present value of money received in the future. Discounting illustrates the time value of a given cash flow by quantifying the opportunity cost of receiving the money in the future and missing a near-term investment opportunity.

Discounted estimates the value of a cash flow that will be received in the future. In this way, discounting quantifies time preference and helps to standardize a timeline for projects because the value of money changes over time. Discounting is also used to evaluate investment decisions and is essentually the reverse of compounding, but the discount rates will vary greatly depending on the circumstances.

Discounting factors in the risk of future cash flows. Higher discounts are applied when the cash flow is riskier and future cash flows are uncertain. High interest rates or beta will also result in higher discounting.