Question

1. Intuitively, what is the discount rate, why do we need it, and how do we choose the appropriate number?

Answer 1

The term discount rate can refer to either the interest rate that the Federal reserves charges banks for short term loans or the rate used to discount future cash flows indiscounted cash flows(DCF) analysis.

In a banking context,the discount lending is a key tool of monetary policy and part of the fed's function as lender last resort.

In DCF,discount rate expresses the time value of money and can make the difference between whether an investment project is financially viable or not.In other words.discount rate serves as hurdle rate in case of evaluation of investment projects.

Non-corpoaret and individaul investors can use their opportunity cost as appropriate discount rate.Corporate investors select their weighted average cost of each source of financing as appropriate discount rate,because for the project or investment to be profitable it has to earn a return greater than the cost of capital.