Discounting is a method of determining investment

The interest rate plays a big and important role for making investment decisions. With its help, you can accurately estimate the investment from their profitability. By investing, the investor first of all infringes on the use of capital assets, and he needs compensation for the damage he is hoping for. Therefore, he expects not only a return on investment, but also a certain income. Thus, when making investments, one should rely on the market interest rate: the project is considered unprofitable if the interest rate is higher than the level of profitability of planned investments. Therefore, it is necessary to take into account the various possibilities of investment in making decisions.

In an effort to maximize their own income, economic entities must act and plan activities in such a way that it produces the greatest effect. It is known that the streams of income from capital investments are not lump-sum, but are stretched for some periods. In this connection, the economy operates with such a concept as discounting.

This is a way of comparing and comparing the future and current cost of capital funds. The meaning of this process is as follows. When planning an investment project, you should measure current current costs with possible future revenues.

It is necessary to be able to apply discounting. This contributes to making the right decision and allows for rational choice. For example, it is necessary to determine under which conditions it is more profitable to provide a loan: 29% per annum for the accrual of quarterly compound interest or semi-annual charge at a rate of 31%.

It is very difficult to solve this problem theoretically, but using mathematical methods, it can be calculated that the 31% discount rate will give the greatest effect . This will allow the bank to prevent loss of revenue associated with an unattractive for the debtor or the unprofitable bank too low interest rate. This pattern is also characteristic for making investment decisions.

Method of discounting

This method, as well as calculating compound interest, is a valuation option, in which the possible change in the time value of money is taken into account . The reason for these changes is not even in inflationary phenomena. After all, money and zero inflation change their value, if you take into account future income from investments and take into account lost profits. And in other cases, discounting is appropriate. This will help to dispel doubts about the correctness of the evaluation of financial assets, for which there is a delay in the time of monetary compensation.

With the help of discounting, revaluation of long-term investment projects is made, which is stipulated by accounting standards.

Discounting is also used to perform financial analysis of cash flows . It should be produced in accordance with the recommendations of the Ministry of Economy to assess the effectiveness of investment projects.

According to these recommendations, discounting is the conversion of the time-varying values of cash flows to their value for one specific period of time. The interval obtained is usually measured in years.

In fact, discounting is an indicator that characterizes the purchasing power of money, their value after a certain period of time. On its basis, compare the current with the prices of future years.

On the method of discounting, you can also say that this is a calculation that allows you to give an answer to how much money you need to invest today in order to get the income set by the investor after a certain number of years.