What is the discount rate?

The discount rate is used to calculate the present value of a future sum of money.

Imagine a customer receives a sum of money in the future, but wants to know its present value. In this case, the discount rate is used to calculate the present value of that money.

The discount rate is calculated based on the level of risk, market conditions, and other economic factors. Discount rates are used in areas such as asset valuation, risk management, investment, and financial planning.

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Formula for calculating discount rate

There are two ways to calculate the discount rate: based on the cost of capital and using the weighted average cost of capital.

Cost of raising capital

To calculate the discount rate using the capital mobilization method, the following formula can be applied:

Discount rate = Profit earned / Amount invested to raise capital

In there:

- Profit is the total value of cash flows generated from the investment, including both revenue and profit.

- Amount invested to raise capital: This is the total amount of money spent on investment.

When calculating the discount rate, attention should be paid to the time unit and it should be adjusted to match the time unit of the investment project, such as days, months, and years.

Weighted average cost of capital

The formula for calculating the discount rate using the weighted average cost of capital method is as follows:

Discount rate = (Discount rate of loan 1 x Discount rate of loan 1 + Discount rate of loan 2 x Discount rate of loan 2 + ... + Discount rate of loan n x Discount rate of loan n) / (Discount rate of loan 1 + Discount rate of loan 2 + ... + Discount rate of loan n)

In there:

CPCV: Cost of capital for each source of funding (i.e., the interest rate or fee paid for that source of funding)

LSCV: Amount of capital raised from each source.

This formula calculates the weighted average of the costs of raising capital corresponding to each source of funding, in order to determine the overall discount rate for the investment project.

The impact of discount rates on banks

With commercial banks

The discount rate is a crucial factor for the operations of commercial banks. This is because the discount rate affects the cost of capital mobilization and the bank's profit margin.

If the discount rate increases, the cost of raising capital will rise, affecting the bank's profitability.

With the State Bank

The discount rate is an important tool in the monetary policy of the central bank. The central bank uses the discount rate to control inflation and stabilize prices.

When the discount rate increases, the cost of capital mobilization for credit institutions rises, leading to a decrease in their lending capacity and affecting their business operations. The State Bank also uses the discount rate to adjust the foreign exchange reduction ratio while simultaneously enhancing the value of the domestic currency.

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Source: https://vtcnews.vn/lai-suat-chiet-khau-la-gi-ar858300.html