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Discount rate

Discount rate

What is the Discount Rate?

The value of today's money is worth more than the value of future money. This is because of the "Net Present Value" of money in that today's money is worth more because it has optionality. I am able to optionally use today's money to pay for another appreciating asset or do whatever I want with that money.

Having this option is valuable and I may want to pay for it. If I'm willing to accept a lower dollar amount relative to the sum of the future cash flows for money today, I am willing to accept a discount. The discount rate is the discount expressed as a percentage of the total value available for the cash flow.

Discount rates can vary based on the quality of the cash flows. If there is risk in collecting the cash flows in its entirety, the discount rate would be higher.

Example of Discount Rate

Let's say I have $1000/mo in rental income. Over the next 12 months, assuming I'm at the start of the 12 month lease, I can expect to get paid $12,000. If I get an offer where the discount rate is 10%, my discount would be $1,200.

This means I can receive $10,800 and it might make sense for me to take this deal if I know I can make more than $1,200 if I had this cash today.

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