Definition
The discount rate reflects the opportunity cost of capital and the riskiness of projected cash flows. For corporate valuation, WACC is the standard discount rate. For equity-only models, cost of equity is used. Higher risk warrants higher discount rates, which reduce present value. The discount rate is the single most impactful assumption in any DCF analysis.
functions Formula
PV = FV / (1 + r)^n
lightbulb Example
A $100 cash flow expected in 5 years discounted at 10% has PV = $100 / (1.10)^5 = $62.09. At 15%, PV drops to $49.72—a 20% reduction from a 5-point rate change.
verified_user Key Points
- Reflects risk and opportunity cost of capital
- Small changes dramatically affect present values
- WACC is standard for enterprise DCF
- Higher risk = higher discount rate = lower value