A discount rate is a metric used to calculate the present value of a future amount of money. In basic terms, it’s like a knob you can turn to adjust the value of money in the future based on interest rates and inflation. For instance, a discount rate of 5% would mean that a $100 payment in a year is worth $95 today.
The discount rate is a crucial tool for financial planning, valuation, and risk assessment. It helps businesses, investors, and governments make informed decisions about long-term projects and investments. Historically, the discount rate was influenced by the concept of time value of money, which made the development of sophisticated financial models possible.