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banking, Business, MBA

Discounting and the Time Preference

Discounting is an interesting concept when it comes to Business Economics. This concept is concerned with future costs and benefits arising in future years being worth less to us than should we achieve those same costs and benefits today. This is important in not only the accounting department, but to decide the cost implications of certain management decisions, or whether to invest in something or simply leave it in the  bank on a fixed interest rate.

Time preference = money today is better than money tomorrow. 

Therefore, all future costs and benefits must be discounted at an appropriate rate of interest. This is referred to as the Discount Rate.

Net Present Value = SIGMA ((St/(1+r) to the power of t)

SIGMA = summation
S = future sum
r = discount rate
t = number of years to elapse before the sum received

Seeing as this concept is a bit awkward to get your head around, lets try a simple example.

A landowner is going to receive a rental income of £5,000 over a 4 year contract. Lets us assume the bank would offer a generous interest rate of 10%. This would therefore make the discount rate 10%. Let us work out the total income for the landlord.

NPV = SIGMA ((st)/(1+r) to the power of t)
NPV = (5000/(1+0.1)) + (5000/(1+0.1)(1+0.1)) + (5000/(1+0.1)(1+0.1)(1+0.1)) + (5000/(1+0.1)(1+0.1)(1+0.1)(1+0.1))

Therefore the contractual sum of income can be seen to decrease in real terms over the period, and this is important when factoring capital investments.


About loganjehall

I focus on building an internal culture focussed on listening to and working alongside customers to build value for all stakeholders. Real lasting change that understands the real needs of the customer is the only way to ensure a dynamic constant state of learning and innovation. I am a highly experienced sales, marketing and business professional with wide ranging experience in varied industries. Having worked in both B2B and B2C I understand sales and business is really about P2P (people to people) and therefore always focus on relationships and engagement. "Business is socialising with a purpose" (Gaping Void) Passion, people, vision, strategy, customers, advocates, believers, innovation, customer engagement, social, knowledge management and appropriate use of technology are vital in the attainment of business goals. I am a co-founder of Movebubble, a new technology startup in #Proptech. This blog is really here to allow me to develop my voice and ideas, and gain feedback from a wider audience than just the lecture or breakout room. Hopefully i can introduce some interesting points, and experiment with digital, marketing, engagement, social media and SEO techniques and tips i am learning on the way. I hope you enjoy my posts, please let me know what you think with some feedback.


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December 2011
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