Why discount future money?
A dollar today can be invested to earn interest, inflation erodes future purchasing power, and future payments carry risk. So we divide future amounts by a discount rate. At 5%, $105 a year from now is worth $100 today, and $1,000 ten years out is worth about $614. The rate reflects opportunity cost, inflation and a risk premium.
How does NPV guide decisions?
Net present value equals the present value of future cash flows minus the upfront cost. A positive NPV means the investment should add value (Brealey et al., 2020). The same math explains why higher interest rates push down growth-stock prices: profits far in the future get discounted more heavily. For a quick doubling estimate, see the Rule of 72.
FAQ
- Is the discount rate the same as the interest rate?
- Related, but the discount rate is a required return that often adds a risk premium.
- Can I use PV to compare a lump sum with an annuity?
- Yes—compare the lump sum with the present value of the payment stream.
Sources reviewed: 2026-10-25
References
- Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of corporate finance (13th ed.). McGraw-Hill.