Discounting Definition
Discounting is the process of estimating the future value of an investment and then subtracting the present value of that investment. The result is the net present value (NPV) of the investment, which is its value in today’s dollars.
To calculate the NPV of an investment, you first need to estimate its future cash flows. These cash flows can be either positive (inflows) or negative (outflows). For example, if you’re considering investing in a new company, your positive cash flows would come from the company’s profits, while your negative cash flows would come from its expenses.
Once you’ve estimated the investment’s future cash flows, you need to discount them back to their present value. This is done by using a discount rate, which is essentially a measure of how much risk is associated with the investment. The higher the discount rate, the lower the present value of the cash flows.
The NPV of an investment is its value today after taking into account all future cash flows, both positive and negative. If the NPV is positive, it means that the investment is worth more than its current price; if it’s negative, it means that the investment is worth less than its current price.
