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See also: Discounts and allowances
For the band of the same name, see Discount (band). Discounts and allowances are reductions to a basic Price of goods or services Discount was a punk rock band that formed in Vero Beach Florida in 1995 and disbanded in 2000

In finance and economics, discounting is the process of finding the present value of an amount of cash at some future date, and along with compounding cash forms the basis of time value of money calculations. The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated Economics is the social science that studies the production distribution, and consumption of goods and services. The time value of money is based on the premise that an Investor prefers to receive a payment of a fixed amount of money today rather than an equal amount in the future The discounted value of a cash flow is determined by reducing its value by the appropriate discount rate for each unit of time between the time when the cashflow is to be valued to the time of the cash flow. Cash flow (also called net cash flow) is the balance of the amounts of Cash being received and paid by a business during a defined period of time sometimes tied For the interest rate charged to Banks for borrowing short-term funds directly from the Federal Reserve, see Discount window. Most often the discount rate is expressed as an annual rate.

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Example

To calculate the present value of a single cash flow, it is divided by one plus the interest rate for each period of time that will pass. Present value is the value on a given date of a future payment or series of future payments discounted to reflect the Time value of money and other factors such as Investment This is expressed mathematically as raising the divisor to the power of the number of units of time.

Consider the task to find the present value PV of $100 that will be received in five years. Present value is the value on a given date of a future payment or series of future payments discounted to reflect the Time value of money and other factors such as Investment The question is what the present value of this future transaction is. Or equivalently, which amount of money will grow to $100 in five years when subject to a constant discount rate?

Assuming a 12% per year interest rate it follows

{\rm PV}=\frac{100 $}{(1+0.12)^5}=56.74 $.

Discount rate

The discount rate which is used in financial calculations is usually chosen to be equal to the cost of capital. The cost of capital is an Expected return that the provider of capital plans to earn on their investment Some adjustment may be made to the discount rate to take account of risks associated with uncertain cashflows, with other developments.

The discount rates typically applied to different types of companies show significant differences:

Reason for high discount rates for startups:

One method that looks into a correct discount rate is the capital asset pricing model. In Finance, the Capital Asset Pricing Model ( CAPM) is used to determine a theoretically appropriate required Rate of return of an Asset, This model takes in account three variables that make up the discount rate:

1. Risk Free Rate: The percentage of return generated by investing in risk free securities such as government bonds.

2. Beta: The measurement of how a company’s stock price reacts to a change in the market. A beta higher than 1 means that a change in share price is exaggerated compared to the rest of shares in the same market. A beta less than 1 means that the share is stable and not very responsive to changes in the market. Less than 0 means that a share is moving in the opposite of the market change.

3. Equity Market Risk Premium: The return on investment that investors require above the risk free rate.

Discount rate= risk free rate + beta*(equity market risk premium)

Discount factor

The discount factor, P(T), is the number which a future cash flow, to be received at time T, must be multiplied by in order to obtain the current present value. Thus for a fixed annually compounded discount rate we have

P(T) = \frac{1}{(1+r)^T}

For fixed continuously compounded discount rate we have

P(T) = e^{-rT} \,

Other discounts

For discounts in marketing, see discounts and allowances, sales promotion, and pricing. In popular usage "marketing" is the promotion of products especially Advertising and Branding However in professional usage the term has a wider meaning of Discounts and allowances are reductions to a basic Price of goods or services Sales promotion is one of the four aspects of Promotional mix. Pricing is one of the Four p's of the Marketing mix. The other three aspects are product promotion and place.

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See also

Lists

The coupon or coupon rate of a bond is the amount of interest paid per year expressed as a percentage of the face value of the bond In Behavioral economics, hyperbolic discounting refers to the Empirical finding that people generally prefer smaller sooner payoffs to larger later payoffs when This is a list of marketing topics. Marketing fundamentals ] Consumer Business Marketing This is a list of articles on general management and strategic management topics This aims to be a complete list of the articles on Economics. Following is a list of accounting topics Accounting Ethics Accounting for risk Accounting information system Topics in Finance include Fundamental financial concepts Finance an overview Arbitrage This is an alphabetical list of notable Economists, that is experts in the social science of Economics.

Dictionary

discount

-verb

  1. To deduct from an account, debt, charge, and the like; to make an abatement of; as, merchants sometimes discount five or six per cent for prompt payment of bills.
  2. To lend money upon, deducting the discount or allowance for interest; as, the banks discount notes and bills of exchange.
  3. To take into consideration beforehand; to anticipate and form conclusions concerning (an event).
  4. To leave out of account; to take no notice of.
  5. To lend, or make a practice of lending, money, abating the discount; as, the discount for sixty or ninety days.

-noun

  1. A reduction in price.
  2. A deduction made for interest, in advancing money upon, or purchasing, a bill or note not due; payment in advance of interest upon money.
  3. The rate of interest charged in discounting.

-adjective

  1. Of goods, available at reduced prices; discounted.
  2. Of a store, specializing in goods at reduced prices.
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