What is a discount factor and how is it used?

Intermediate

Answer

A discount factor is the multiplier 1/(1+r)^n that converts a future cash flow at time n into its present value at discount rate r. Multiplying each year's cash flow by its discount factor and summing gives the present value used in NPV. Discount factor tables or formulas provide these values.

Discount factor at 10%, year 3 = 1/(1.1)^3 = 0.751.

Real-world example The analyst multiplies each year's project cash flow by its discount factor to get present values.

Common follow-ups: What does the discount factor convert? | How is NPV built from it?

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