Discount rate what is

Based on the concept of the time value of money , DCF analysis helps assess the viability of a project or investment by calculating the present value of expected future cash flows using a discount rate. Such an analysis begins with an estimate of the investment that a proposed project will require.

Then, the future returns it is expected to generate are considered. Using the discount rate, it is possible to calculate the current value of all such future cash flows. If the net present value is positive, the project is considered viable. If it is negative, the project isn't worth the investment. In this context of DCF analysis, the discount rate refers to the interest rate used to determine the present value.

What is the appropriate discount rate to use for an investment or a business project? While investing in standard assets, like treasury bonds, the risk-free rate of return is often used as the discount rate.

On the other hand, if a business is assessing the viability of a potential project, the weighted average cost of capital WACC may be used as a discount rate. This is the average cost the company pays for capital from borrowing or selling equity. In either case, the net present value of all cash flows should be positive if the investment or project is to get the green light.

Future cash flows are reduced by the discount rate, so the higher the discount rate the lower the present value of the future cash flows. A lower discount rate leads to a higher present value. As this implies, when the discount rate is higher, money in the future will be worth less than it is today.

It will have less purchasing power. When considering an investment, the investor should use the opportunity cost of putting their money to work elsewhere as an appropriate discount rate.

That is the rate of return that the investor could earn in the marketplace on an investment of comparable size and risk. A business can choose the most appropriate of several discount rates. This might be an opportunity cost-based discount rate, or its weighted average cost of capital WACC , or the historical average returns of a similar project. In some cases using the risk-free rate may be most appropriate. Federal Reserve. Federal Reserve History. European Central Bank. Fixed Income Essentials.

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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. The primary credit program is the Fed's main lending program for eligible banks in "generally sound financial condition. The secondary credit program is available to financial institutions that are not eligible for the primary credit program, but still require short term loans to fund short term needs or to resolve severe financial difficulty.

Loans from the secondary credit program carry a higher discount rate than loans in the primary credit program. The third program is the seasonal credit program, available to smaller financial institutions with recurring fluctuations in their cash flow. A common example are agriculture banks, whose loan and deposit balances fluctuate each year with the various growing seasons. The discount rate on these loans is determined from an average of selected market rates of comparable alternative lending facilities.

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Industries to Invest In. Getting Started. Planning for Retirement. In banking, it is the interest rate the Federal Reserve charges banks for overnight loans.

Despite its name, the discount rate is not reduced. During major financial crises , though, the Fed may lower the discount rate — and lengthen the loan time. In investing and accounting, the discount rate is the rate of return used to figure what future cash flows are worth today.

If you need help understanding this or any other financial concepts, consider working with a financial advisor. When the discount rate comes up in financial news, it usually refers to the Federal Reserve discount rate.

This is the rate the Fed charges commercial banks for short-term loans of 24 hours or less. Sometimes, banks borrow money from the Fed to prevent liquidity issues or cover funding shortfalls.

Those loans come from one of 12 regional Federal Reserve banks. Banks use these loans sparingly, since loans from other banks typically come with lower rates and less collateral.