Why money today is worth more than money tomorrow
A euro you have today is worth more than a euro you only get years from now. Today you could invest it safely, and the future is uncertain. Discounting converts future money back to its value today – the further away and the more uncertain, the less it is worth today.
The idea
Imagine someone offers you a choice: €100 today or €100 in five years. Almost everyone takes the money today. You could invest it and have more than €100 in five years. And who knows whether the promise will still hold in five years.
Discounting turns this thought around. It asks: how much would I need today for it to be as good as an amount in the future? A DCF asks exactly this question for every year in which a company earns money.
Compounding first, then discounting
If you invest €100 at 9% a year, you have €109 after one year. In the second year you get 9% on the €109, so interest on the interest too. After five years it is €153.86. That is compounding.
Discounting is the way back. If €153.86 in five years is just as good as €100 today, then €100 in five years is worth only €64.99 today.
The formula
- r
- discount rate, for example 9% = 0.09
- t
- number of years until the money arrives
For €100 in five years that means: €100 ÷ 1.095 = €100 ÷ 1.539 = €64.99. That is all there is to it.
The worked example
This is what €100 you only receive later is worth today, discounted at 9%:
| Money arrives in | Factor | Value today |
|---|---|---|
| 1 year | 0.917 | €91.74 |
| 5 years | 0.650 | €64.99 |
| 10 years | 0.422 | €42.24 |
| 20 years | 0.178 | €17.84 |
| 30 years | 0.075 | €7.54 |
What stands out is how fast the value shrinks. €100 in 30 years is not even worth €8 today. That is why the near years matter most for fair value – and why a company that is only supposed to earn money in the distant future is so hard to value today.
Which rate?
The discount rate is the minimum return you expect for the risk to be worth it. Think of it as two parts: the interest you would get without risk, for example on a safe government bond, and a premium for the fact that a stock can swing and a company can fail.
That leads to a simple rule: the more uncertain the company, the higher the rate. A stable utility justifies a lower rate than a young technology company.
How strongly the rate matters
In the article on fair value, the made-up Example Inc. came to a fair value of €199.23 per share at 9%. With all other assumptions the same, a different rate gives:
| Rate | Fair value | vs. 9% |
|---|---|---|
| 8% | €236.36 | +19% |
| 9% | €199.23 | – |
| 10% | €172.02 | −14% |
A single percentage point moves fair value by almost a fifth. That also explains why share prices often react to rising or falling interest rates: when rates change, the value of future profits changes.
Three common mistakes
Choose the rate yourself.
In Delta Metron the discount rate is not a hidden number. You see what is used, set it yourself and see right away how fair value changes – for more than 6,000 stocks. Sign up for free: The first 100 on the waitlist pay €5 instead of €10 a month at launch, for life.
Frequently asked questions
What is the difference between discounting and compounding?
Compounding goes from today into the future: what becomes of my money? Discounting goes from the future back to today: what is a future amount worth today? It is the same calculation, just in the other direction.
What does inflation have to do with it?
It is one more reason why future money is worth less. If you calculate with usual interest rates and cash flows in euros, expected inflation is already included and does not need to be subtracted again.
What is WACC?
The abbreviation stands for a company's weighted average cost of capital: the return owners and lenders demand together. Many DCF calculations use it as the discount rate. The idea behind it is the same as above.
Is there one right rate?
No. It is an assumption, just like growth. What matters is that you choose it deliberately and can justify it – and that you see how strongly your result depends on it.
Not investment advice. All content is for informational and educational purposes only. Example Inc. is made up.