Discounting

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To “discount” the value of a payment due in the future is to calculate the value of that future right today (its “present value”). You do this by basically subtracting, rather than adding, interest. This is sort of like time travel for a dollar bill and it is amazing no-one has yet premised an art-house sci-fi on it.

In the simplest terms, if I have a dollar today I can put it in the bank and earn interest on it. Time’s arrow running forward, in a year’s time, my dollar will be worth a dollar ten to me. So by the same token, a dollar ten in a year must be worth a dollar today.

Discounting is just the process of asking what would happen if you turned time’s arrow the other way: If I will have a dollar in a year, how much would I have today? What sum, compounded with interest over twelve months, will give me a dollar?

Why would anyone care? Well, for one thing, if I know the present value of a future cashflow, I can sell it now at that discounted value — this is called “monetising”.