Economics Time Value Of Money Questions Medium
The discount rate is a crucial factor in determining the present value of future cash flows. It represents the rate of return or the opportunity cost of investing in a particular project or investment.
When the discount rate increases, the present value of future cash flows decreases. This is because a higher discount rate implies a higher opportunity cost of investing in a project, meaning that the investor would require a higher return to compensate for the risk or forgoing other investment opportunities. As a result, the future cash flows are discounted at a higher rate, reducing their present value.
Conversely, when the discount rate decreases, the present value of future cash flows increases. A lower discount rate indicates a lower opportunity cost, meaning that the investor would be willing to accept a lower return. Consequently, the future cash flows are discounted at a lower rate, resulting in a higher present value.
In summary, the discount rate has an inverse relationship with the present value of future cash flows. A higher discount rate decreases the present value, while a lower discount rate increases it.