The interest rate plays a large and important role in making investment decisions. With its help, it is possible to fairly accurately assess the investments on the part of their profitability. Making investments, the investor first of all infringes on the use of capital funds, and he needs compensation for the damage that he hopes. Therefore, he expects not only a return on investment, but also a certain income. Thus, when making investments, you should rely on the market interest rate: the project is considered unprofitable if the interest rate is higher than the rate of return on the planned investments. Therefore, it is worth considering the various investment opportunities when making decisions.
In an effort to maximize their own income, economic entities must act and plan activities in such a way that it gives the greatest effect. It is known that the flow of income from investment is not one-time, but stretched for some periods. In this regard, the economy operates with such a concept as discounting.
This is a way of comparing and correlating the future and current value of capital assets. The meaning of this process is as follows. When planning an investment project, you should measure current current costs with possible future income.
You must be able to apply discounting. This contributes to making the right decision and allows for rational choice. For example, it is necessary to determine on what conditions it is more profitable to provide a loan: 29% per annum for accruing quarterly compound interest or for semi-annual accrual at a rate of 31%.
Theoretically, this problem is very difficult to solve, but using mathematical methods, we can calculate that the 31% discount rate will give the greatest effect . This will allow the bank to prevent the loss of income associated with unattractive to the debtor or disadvantageous to the bank too low interest rate. This pattern is also characteristic for making investment decisions.
Discount method
This method, as well as the calculation of compound interest, is an assessment option in which the possible change in time of the value of money is taken into account . The reason for these changes is not even in inflationary phenomena. After all, money and at zero inflation change their value, given the future income from investments and take into account the lost profit. And in other cases, discounting is appropriate. This will help to cast aside doubts about the correctness of the valuation of financial assets for which there is a delay in the time of cash compensation.
With the help of discounting, the cost of long-term investment projects is reassessed, which is provided for by accounting standards.
To perform financial analysis of cash flows, discounting is also used. It should be produced in accordance with the recommendations of the Ministry of Economy to assess the effectiveness of investment projects.
According to these recommendations, discounting is the reduction of cash flows of different values to their value for one specific period of time. The resulting interval is usually measured in years.
In fact, discounting is an indicator that characterizes the purchasing power of money, its value after a certain period of time. Based on it, the current prices are compared with the prices of future years.
The discount method can also be said to be a calculation that allows you to give an answer to the amount you need to invest today in order to get the income set by the investor after a number of years.