Discount Rate
Definition:
The discount rate is the rate of interest used to calculate the present value of a future sum of money or the future value of an investment. It is the rate of return that an investor would receive on an investment if it were made today.
Formula:
The formula for calculating the discount rate is:
$$r = frac{n(i) – 1}{n-1}$$
where:
- $r$ is the discount rate
- $n$ is the number of years
- $i$ is the annual interest rate
Calculation:
To calculate the discount rate, you need to know the number of years, the annual interest rate, and the formula above. Simply substitute the values into the formula and solve for $r$.
Example:
Calculate the discount rate for an investment that will return $10,000 in 5 years at an annual interest rate of 5%.
$$r = frac{n(i) – 1}{n-1}$$
$$r = frac{5(0.05) – 1}{5-1}$$
$$r = 2.5%$$
Therefore, the discount rate for this investment is 2.5%.
Uses:
- Calculating present value
- Calculating future value
- Determining the required return for an investment
- Estimating the cost of borrowing money
Key Points:
- Discount rate is the rate of interest used to calculate present or future value.
- Formula for calculating discount rate involves number of years, annual interest rate, and the formula.
- Discount rate is used in various financial calculations.
