Discount Rate

Discount means an off or rebate on the product’s price offered by the shopkeeper or the marketer. However, in corporate finance, the discount rate is the rate of return used to discount future cash flows back to their present values.

The manufacturer gives the marked price, but the selling price is when the shopkeeper sells them with a reduction in the price called the discount. 

The formula to calculate discount is

Discount= Marked Price – Selling Price

Discount(%)= (Discount/Marked Price)*100

What is a discount rate?

The price that refers to less in any selling price is known as the discount rate. It decreases the actual value of any product. This is based on profit and loss. When the producer is getting any profit by giving a discount to the consumers, this is applied. This is calculated by the difference in the selling price and the market price value. When we talk about the market price, it is the price marked on any product, and the selling price is the price at which the shopkeeper is selling this to the customer. This discount rate is marked on the packet itself to be visible to the customers, and they can buy that product more. This is the easiest way to sell out the products in the market.

Why do we use discount rates?

We mainly use the Discount Rate to calculate the Net present value, also called NPV, which is used for the analysis of Discount cash flow. The Discount Rate is

used for the following purposes-

• Used to calculate the time value of money

• Used for making the investment-related decisions

• Make the investment even more capable

• It makes the investment more comparable

• It is used to calculate the risk related to any investment

• Used for representing the opportunity cost

Types of Discounts

• Trade Discount

The distributor uses this for the retailer and not for the email customer that

purchases it. This is offered so that the product can be sold quickly. 

• Quality Discount

This type of discount is given when the customer takes many goods.

• Promotional Discount

This discount is given when any product is to be promoted, or stock is to be cleared.

Different kinds of Discount Rate

There are many types of Discount rates used to calculate Discount cash flow in corporate finance. They are-

• Cost of equity- This is used to calculate the equity value of the investment.

• Risk-free rate- This is used for keeping the account of the time value of money.

• Cost of debt- This is used to calculate the value of the discount rate formula bond, which is also called fixed-income security. 

• WACC (Weighted Average Cost of Capital)- This is used to calculate the enterprise value of the investment or the firm.

• Pre-defined hurdle rate- This is used in the corporates’ internal projects to calculate the investment rates.

Disadvantages of Discount Rate

• While Discount Rate is very beneficial for financial modeling and helps in calculating the Discount Rate, it works on an assumption basis. We only make the best guess of what may happen in the future.

• Another disadvantage of Discount Rate is that only one rate can be predicted at one point, whereas the value of interest and the value of risks change continuously. This gives us some ambiguity in the values.

• When we use the WACC type of Discount Rate calculation, it uses the historical volatility, which is not a good measure be calculate the risk for something that will happen in the future.

Conclusion

In this article, we mainly studied the discount and the discount rate. A discount is a reduction in the value of items that the shopkeeper gives on the price written on the items that are the marked price. The shopkeepers mainly do this to increase the sales and good sell of the old stocks. We saw why the shopkeepers provided the discount and how to calculate the discount, the discount rate formula, and the Discount Rate definition. Then the various disadvantages of using Discount rates and their types also.