Discount Factor Calculator

Use the Discount Factor Calculator to calculate the discount factor (a decimal number multiplied by a cash flow value to discount it back to the Present Value).

Discount Factor Calculator
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Using the discount factor for financial calculations

Discount Factor Calculator. This image provides details of how to calculate Discount Factor using a calculator and notepad. By using theDiscount Factor formula, the Discount Factor Calculator provides a true calculation of the value of money changes according to the time difference between present and future and it is created by discounting the future value back to the present value

Cash flows are generated in every business, but will they be worth as much in the future as they are today? This can be said for cash flows in general as well. The concept of "time value of money" is the biggest factor when you calculate the discount factor for future cash flows to find out their present value. It is used for assessing the time value of money, and is referred to as the discount factor or discounting. Put simply, the value of money changes according to the time difference between present and future and it is created by discounting the future value back to the present value.

You can calculate the discount factor manually, it involves several steps and the calculations are rather complex, However, to avoid the manual calculations you can use the online calculator, let's take a look at both ways.

Electronic calculator and manual calculation of the discount factor method

The discount factor calculates the present value of future cash flows. You can follow the below steps or calculate the discount factor manually:

The first step is to determine the discount rate, based on current market situation that is obtained on a similar kind of investment.

The second step is to decide on how long you want your money to be kept invested in order to get the returns.

Third step is to assume or find out the compounding period (explained below) by market information. This can be monthly, quarterly, or annually, etc.

Fourth step is to follow the below formula in order to find out the discount factor:

Discount Factor = 1 / (1 x (1 + Discount Rate)Compounding Period Number)

Let's discuss the components of the formula:

  • Discount rate: This is a growth rate that you are expecting or have estimated for your future cash flows.
  • Compounding period: A compounding period means a period after which the earned or payable interest is added to the principal amount of investments.

The other way to calculate the discount factor is by entering the above mentioned components into the Discount Factor Calculator created by iCalculator. Let's have a look at some benefits of using the discount factor calculator.

Why use the discount factor calculator

On the basis of your inputs, the calculator will provide you with the results instantly without having to do the manual calculations. The Discount factor calculator is online and saves you a lot of time.

The results obtained from the calculator are an indicator of how well your investments can do in the future. You can use the discount rate for comparing various plans offered by different investment agencies in order to get the best available plan.

The Discount factor is relevant in the calculation of other kinds of values and other financial models. Let's have a look at them.

Relevance of using the discounting factor

The discount factor is used for assessing risk on investment. The higher the discount factor the higher the risk. This method captures the effects of compounding that is helpful in calculating:

  • Discounted cash flow: This method is used to estimate the value of an investment. This is done on the basis of the future cash flows of that investment. This method is used in businesses to assess the profitability of projects by calculating their present value of future estimated returns it will generate using the discounting factor. A project is considered viable if its net present value is positive and vice-versa. When assessing the potential success of the projects in businesses they may use the WACC (weighted average cost of capital) as a discount rate.
  • Time value of money: The discount factor is used in the valuation of time value of money as well. The time value of money means the money you have today will be worth less in the future if not invested to earn returns, because of factors like inflation. Even the money deposited in savings account will earn interest, thus proving the time value of money.
  • Application in financial modeling: The discount factor is used in finance modeling to give a better view of the effects of discounting. This is used while performing financial modeling in excel. This also ensures the viability of net present value formula.
  • Other important calculations: Other than this the discount factor is also used as a substitute for XNPV function and XIRR function. This shows the difference between each time period by using specific dates in each time period.

Additionally, discount factor is used by insurance companies as well as for pension calculations for discounting the liabilities of the applicants.

This is also useful in the global financial market for unsecured promissory notes such as commercial paper and treasury bills. The time value of money is also particularly useful when paying tax bills. Delaying the payment of tax until the deadline technically means you pay less tax and the value of the money has decreased.