Introduction:
Discount Rate is the most common variable studied in the field of accountancy/business, as it encapsulates an interest rate marked over commercial banks and other financial institutions for the amount received on the behalf of Federal Reserve’s discount opening.
It’s the same rate, which finance professionals use while generating ‘discounted cash flow’ and it’s no different at all. A supreme benefit behind using ‘discount rate’ is its ability to evaluate the time value of money along with the ups and downs associated with future cash flows.
Who Else Use Discount Rate?
Even companies planning for pensions as well as insurance programs can create some positive effects over their liabilities through discount rate. It is mandatory that financial institutes and commercial banks follow the exact discount rate mentioned by the ‘Federal Reserve’ rather than depending on market rate of interest, which creates confusions and inaccuracies in the work.
Example:
The best example of ‘Discount Rate’ as per its analysis through ‘Discount Cash Flow’ would be an assumption of having $1000 in the account.
In order to evaluate its genuine amount or the present value of what we have today, we must discount it with a specific amount of interest rate. Moving on with our assumptions: suppose, the discount rate is set to 10%, the amount of $1000 would convert into $909.09 in the spur of the moment.
The calculated amount went through a discount-rate formula which presented us the equation ‘(1,000 / [1.00 + 0.10])’ giving us a strong recommendation about the present value of $1000 in a year. We can calculate the desired present value on different amounts by rearranging the number of years and the discount rate in the equation, accordingly. Companies have exceeded the usage of the discount rate as it helps in calculating the present value of numerous variables in the business field.