Discounting is the process of finding the present value of a future payment or a series of cash flows, based on the time value of money. Discounting reflects the idea that money today is worth more than the same amount of money in the future, because money today can be invested and earn interest or returns. Discounting also accounts for the risk and uncertainty associated with future cash flows.

To discount a future payment or a cash flow, we need to apply a discount factor, which is usually the interest rate or the required rate of return. The discount factor represents the opportunity cost of investing the money today instead of receiving it in the future. The higher the discount factor, the lower the present value of the future payment or cash flow.

The formula for discounting a single future payment is:

where:

• PV is the present value of the future payment
• FV is the future value of the payment
• i is the discount factor (interest rate or required rate of return)
• n is the number of periods until the payment is received

For example, if you expect to receive $1,000 in one year, and the discount factor is 10%, the present value of the future payment is:

PV=1,000/(1+0.1)¹

PV=1,000/1.1

PV=909.09

This means that receiving $1,000 in one year is equivalent to receiving $909.09 today, given the discount factor of 10%.

Discounting is used in many areas of finance, such as bond valuation, stock valuation, project evaluation, and capital budgeting. Discounting helps investors and managers compare the value of different investments and projects, and make informed decisions based on their expected future cash flows and required rates of return.