Question

Explain Discount rate, why it is important and its advantages?

Answer 1

In the subject of corporate finance discount rate refers to the rate of return on an investment made where the future cash flows are convert to the present cash flow with the help of discounting. Therefore this helps in assesing the rate of return expected by the investors. It helps in determination of net present value of an investment and this rate is the company's weighted average cost of capital.

Importance of discounting rate.

Discount rates helps the investors in assesing the risk in an investment and it also sets a benchmark of future investments. On the other hand in the perspective of a corporate company the discount rate is referred to as hurdle rate where the same discounting rate helps the business asses whether the business investment shall yield them profits or not.

Advantages of discounting rate:

It helps in giving a rear view picture of an investment decision which helps the investors to make appropriate and profitable investment. A high discounting rate indicates to give lower returns after a long period of time therefore this helps in assesing the risk of the investor beforehand using capital budgeting techniques such as net present value, discounted payback etc.