Question

46. What is a discount rate and what are the implications for using a higher discount rate versus a lower discount rate to evaluate a project with a lot of up-front costs and benefits that come over a long period of time?

Answer 1

A discount rate is the intrest rate used to determine the present value of future cash flow. This helps to determine if the future cash flow bfrom a project for or investment will be worth more than the capital outlay neede to fund the project or investment in the present. Where the discount rate is the number that needs to meets or exceeds the cost of capital.

Higher discount rates results in lower present values. This is because the higher discount rates indicates that money will grow more rapidly overtime due to the higher rates of earnings. Suppose two different projects will a $100 cash flow one year but one project is riskier that the other. So higher discount rates implies greater uncertainty the lower the present value of future cash flow.

Sacrifice the larger fraction of current wealth to improve more uncertain future. This is done by reducing rate Economy is expected to accelerate excess reserve in commercial banks throughout the economy and expands the money supply. On the other hand higher discount rates decrease excess reserves in commercial banks and contracts the money supply.