discount rate - the interest rate is the one that is used in the reduction of future cash flows to their value at the moment.Its calculation is probably one of the most pressing and complex issues that arise in the financial evaluation of any investment project.From its correctness it depends on what the final value will be present cash value.
If you apply a low rate, the present value of expected future cash flows may be overstated.This will entail a range of investor inefficient projects, causing him to suffer severe losses.Excessively high rate, in turn, could lead to losses that have actually - a missed opportunity to generate income.
discount rate thus represents the rate of return as a percentage, which must receive the investor on the invested capital.That is, the project is considered to be attractive for investors when the rate of return for a discount rate is higher than any other possible capital investments having similar risk.
discount rate, on the other hand, is a reflection of the value of money considering the risks and the time factor, because the real money which the person has at the moment, is far preferable (they have a great value) equal to it the amount of money it expects to recover in the future.
This is due to several reasons, for example, that:
- there is always the risk of the estimated amount just does not get;
- amount available could make a profit, for example, being put on deposit in the bank.
- amount available as a result of inflation will lose its purchasing power.
The discount rate includes the following options:
- inflation;
- rate risk investments (for each case);
- minimum level of profitability that can be guaranteed.
discount rate, which are calculated on the basis of different methods in practice is often determined experimentally.This takes into account both the requirements of the investor and the investment bank, attracting required funds for the project.
In Russian conditions, investment activity is always paired with a variable level of risk, therefore, with the ever-changing levels of income and expenses.For this reason, in practice, the profitability of the project is rarely calculated using the method of direct capitalization, without taking into account the discount rate.
discounted cash flows, taking into account discounting, of course, much more accurately reflect the value of the available income.
The most common technique for determining the discount rate of financial capital flows include the following models:
1. For your own:
- assessment of capital assets;
- cumulative construction.
2. For the investment:
- weighted average cost of capital.
fundamental point in the process of discounting - to set a specific discount rate.In economic terms the discount rate is that rate of return that would be obtained if these funds were available from the organization.With the discount rate determines the amount that the investor will have to pay today, in the future have the right to receive the expected amount.
discount rate is needed to:
- produce a more accurate calculation of return of the project;
- compare the performance of existing project with the lowest rate of return when investing in a similar business.
