46. What is a discount rate an
46. What is a discount rate and what are the implications forusing a higher discount rate versus a lower discount rate toevaluate a project with a lot of up-front costs and benefits thatcome over a long period of time?
Answer:
A discount rate is the intrest rate used to determine thepresent value of future cash flow. This helps to determine if thefuture cash flow bfrom a project for or investment will be worthmore than the capital outlay neede to fund the project orinvestment in the present. Where the discount rate is the numberthat needs to meets or exceeds the cost of capital.
Higher discount rates results in lower present values. This isbecause the higher discount rates indicates that money will growmore rapidly overtime due to the higher rates of earnings. Supposetwo different projects will a $100 cash flow one year but oneproject is riskier that the other. So higher discount rates impliesgreater uncertainty the lower the present value of future cashflow.
Sacrifice the larger fraction of current wealth to improve moreuncertain future. This is done by reducing rate Economy is expectedto accelerate excess reserve in commercial banks throughout theeconomy and expands the money supply. On the other hand higherdiscount rates decrease excess reserves in commercial banks andcontracts the money supply.
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