What is a discount factor?
The discount factor is the amount that the future sum of money must be multiplied to calculate its value at present. This calculation is the product of the theory of money at a time value that states that money over time loses value. To perform the equation for the discount factor, the discount interest rate that will be influenced by inflation, and the time between the future date and present must be known. In most cases, the factor is used to calculate what the dollar will be evaluated in the future.
There is an old adage that says the dollar today cannot buy almost as much as in the past. The reason is the theory of money from time. The dollar will always cost more than this theory in the future. For this reason, investors can use a discount factor to try to assess how much the promised money in the future is really worth it for them.
The discount factor calculation requires both the discount interest rate and the time between the studyfor the future time and present. Imagine, for example, that the interest rate is five percent and the time in question is in two years. The respective equation states that the present value equals one plus the interest rate, which is raised to the strength of time in years, and finally divided by 1.
In this case, the interest rate of 5 percent or 0.05 for mathematical purposes is added to one, which brings 1.05. This amount is then raised to the second power, because time is two years in the future. The resulting discount factor 1,1025 is then divided by one that provides a quotient of 0.907. With this planned inflation rate, this means that one dollar currently has about 91 cents in the future.
by making simple multiplication, the discount factor can then be used to measure the value of any future amount of money at present. Using the above example, $ 1,000 (USD) in two years would have a value of approximately $ 910. For this reason, investors could consider it wiser to take $ 1,000 and invest it now, withHe writes than to wait for a promised $ 1,000 return from a line.