Question

If you are calculating the present value of some cash to be received in the future, would you arrive at a higher or lower value if you increased the discount rate?

Answer 1

The more will be the discount rate, the lower value will be arrived at :

For example :

Consider there would be $100 cashflows from a project at the end of each year for 3 years and the discounting rates are 10% and 15%

Now PVIFA for 3 years would be

year	15%	10%
1	0.8696	0.9091
2	0.7561	0.8264
3	0.6575	0.7513
Total	2.2832	2.4869

Pv of cash flows at 10% would be = $100*2.4869 = $ 248.69 whereas,

Pv of cashflows at 15% WOULD BE =$100*2.2832 =$ 228.32

Now from the above illustration we can construe that higher the discounting rate, lower would be the present value of cash flows.

Detailed Explanations :

• Present value is the concept that states an amount of money today is worth more than that same amount in the future. In other words, money received in the future is not worth as much as an equal amount received today.
• Money not spent today could be expected to lose value in the future by some implied annual rate, which could be inflation or the rate of return if the money was invested.
• Calculating present value involves making an assumption that a rate of return could be earned on the funds over the time period.

Present value is the concept that states an amount of money today is worth more than that same amount in the future. In other words, money received in the future is not worth as much as an equal amount received today.

Receiving $1,000 today is worth more than $1,000 five years from now. Why? Two factors impact whether an amount today is worth more than the same amount in the future.

Conclusion :

Present value (PV) is the current value of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.