One common use for discount rates is to boil a sequence of future cash flows down to a single net present value number. Then based on that net present value number, you make some decision.Then that interest rate could also represent the discount rate for future cash flows.
The best choice of discount rate might depend on what you are trying to accomplish, and what your decision is about.
If you're attempting to estimate the net present value of a range of candidate investment options, so you can rank them and invest in the most attractive ones, one way to set the discount rate is if there's a default "next best alternative" investment that you'd allocate 100% of your funds to if none of the candidate investment options were attractive. Then you could set your discount rate to your estimated rate of return of your default "next best alternative investment". If you estimate the NPV of a candidate investment is negative, this means that it's inferior to your "next best alternative" investment.
That said, NPV estimates are highly sensitive to both the choice of discount rate and forecasts of future cash flows. Forecasting what will happen in the future is hard, especially over long time horizons. There's a fair chance that whatever parameters you pick, your NPV estimates will be largely nonsense. E.g. for estimating the NPV of a large infrastructure project, perhaps half of the estimated NPV may depend on the "tail value" of the project at the end of a 20 year time horizon. The estimate of "tail value" after 20 years is likely highly sensitive to a bunch of assumptions and parameters, and probably going to be nonsense.
Statistics: Posted by pseudoiterative — Thu Jun 13, 2024 5:43 am — Replies 7 — Views 531