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Chapter 3

2.1 Discounting

Discounting performs the opposite calculation to compounding. It calculates the
present value of an amount received or paid in the future.

In a potential investment project, cash flows will arise at many different points in time,
with different time values. To make a useful comparison of the different flows, they
must all be converted to a common point in time, usually the present day, i.e. the
cash flows are discounted.

The present value (PV) is the cash equivalent now of money
receivable/payable at some future date.

Formula for discounting:

-n
Present value (P) = Future value (F) × (1 + r)

This is just a rearrangement of the formula for compounding.

-n
(1 + r) is called the discount factor (DF).

Question 2

Discounting

What is the present value of $65,000 receivable in 6 years’ time if the applicable
interest rate is 7%?

P = F × (1 + r)-n

P = $65,000 × 1.07-6 = $43,312

Illustrations and further practice

Now try TYU 2 from Chapter 3

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