Discount Factor

If you’re dabbling in financial modeling for funzies, you’ll definitely need to know about the discount factor. The discount factor is a number you can use to multiply your cash value by in order to get the present value.

Think about it this way: you might be projecting the cash flow of your future dominatrix lemonade company (the market wants what it wants), but you realize that money in five years won’t be able to buy what it can today. Today, lemonade might cost $3, but in five years, the inflation rate might cause lemonade to cost $3.50. That means the nominal amount of $3 can buy you more today than it will buy you in the future. Like...if you went back in time, you’d be rich.

Using the discount factor, you can bring money “from the future” into today’s dollars in terms of value. The discount factor takes out the effect of inflation so that you can calculate the present value of your cash flow.