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DISCOUNT RATE

It is assumed that a monetary unit received today is worth more than a monetary unit to be received a year from now. This assumption requires that, in order to determine the present value of future sums, the analyst use an interest rate to discount these future sums. If i is the assumed annual interest or discount rate, expressed as a decimal, the present value of x monetary units to be received in n years from now is given by the formula:

     Present value =       X
                         ------
                         (l+i)n

Discount rates are used when comparing alternatives that differ in the time-character of their flows of costs and benefits; to compare them, costs and benefits are discounted to the same year. There are no clear-cut rules as to what an appropriate discount rate should be in a given case.

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