Editing Discounted cash flow (section)

==Discount rate==
The act of discounting future cash flows asks "how much money would have to be invested currently, at a given rate of return, to yield the forecast cash flow, at its future date?"  In other words, discounting returns the [[present value]] of future cash flows, where the rate used is the cost of capital that ''appropriately'' reflects the risk, and timing, of the cash flows.

This "'''required return'''" thus incorporates:
# [[Time value of money]] ([[Risk-free interest rate|risk-free rate]]) – according to the theory of [[time preference]], investors would rather have cash immediately than having to wait and must therefore be compensated by paying for the delay.
# [[Risk premium]] – reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all. 
For the latter, various [[economic model|models]] have been developed, where the premium is (typically) calculated as a function of the asset's performance with reference to some macroeconomic variable – for example, the CAPM compares the asset's historical returns to the "[[market portfolio|overall market's]]"; see {{slink|Capital asset pricing model|Asset-specific required return}} and {{slink|Asset pricing|General equilibrium asset pricing}}.

An alternate, although less common approach, is to apply a "fundamental valuation" method, such as the "[[T-model]]", which instead relies on accounting information.
Other methods of discounting, such as [[hyperbolic discounting]], are studied in academia and said to reflect intuitive decision-making, but are not generally used in industry. In this context the above is referred to as "exponential discounting".

The terminology "[[expected return]]", although formally the [[expected value|mathematical expected value]], is often used interchangeably with the above, where "expected" means "required" or "demanded" by investors.

The method may also be modified by industry, for example various formulae have been proposed when choosing a discount rate [[healthcare economics|in a healthcare setting]];<ref>{{Cite journal|last1=Lim|first1=Andy|last2=Lim|first2=Alvin|date=2019|title=Choosing the discount rate in an economic analysis|journal=Emergency Medicine Australasia|language=en|volume=31|issue=5|pages=898–899|doi=10.1111/1742-6723.13357|pmid=31342660|s2cid=198495952|issn=1742-6723}}</ref>
similarly in a [[Valuation_(finance)#Valuation_of_mining_projects|mining setting]], where risk-characteristics can differ (dramatically) by [[mineral rights|property]].<ref>[[Queen's University at Kingston|Queen's University]] minewiki (N.D.). [https://web.archive.org/web/20160710071306/http://minewiki.engineering.queensu.ca/mediawiki/index.php/Discount_rate "Discount rate"]</ref>