Discount factor
Discount factor is the multiplier 1 ÷ (1 + r)^n that converts a cash flow due n periods from now into its present value today, given discount rate r; it is always between 0 and 1.
See it move
A cash flow of €12,500 arrives in two years, at a 25% discount rate. The discount factor is 1 ÷ (1.25)² = 1 ÷ 1.5625 = 0.64. Multiplying the future cash flow by the discount factor gives its present value: €12,500 × 0.64 = €8,000, today's equivalent of that future euro amount.
The formula
Variables
- Discount factor (decimal, 0 to 1)
- Discount rate per period (decimal)
- Number of periods until the cash flow (periods)
Converts one euro received n periods from now into its equivalent value today at discount rate r; multiply any future cash flow by DF to get its present value.
Check yourself
A cash flow of €20,000 is due in 3 years. Using an annual discount rate of 10% and a discount factor of 0.7513 (the standard four-decimal table value for 10%, period 3), what is its present value?