what is the discount rate

A discount rate is the interest rate used to determine the present value of future cash flows in a discounted cash flow (DCF) analysis. In other words, it is the rate of return used to discount future cash flows back to their present value. The discount rate is used to calculate the Net Present Value (NPV) of a business as part of a Discounted Cash Flow (DCF) analysis. The discount rate is also used by the Federal Reserve to charge commercial banks and other financial institutions for short-term loans. The discount rate is applied at the Feds lending facility, which is called the discount window. The cost of capital and the discount rate work hand in hand to determine whether a prospective investment or project will be profitable. The discount rate usually takes into consideration a risk premium and therefore is usually higher than the risk-free rate.