In financial modeling, discounting is the process of translating future cash flows into present value. It allows analysts to make meaningful comparisons and assess the true value of a stream of income over time.

The Mathematical Basis

The most foundational formula in DCF valuation is:

$PV = \frac{FV}{(1 + r)^n}$

Where:

• PV - Present Value;

• FV - Future Value (e.g., $50,000);

• r - Discount Rate (e.g., 10% or 0.10);

• n - Number of periods (e.g., years).

This formula reflects compound discounting—each additional year pushes the cash flow further into the future, reducing its value more significantly.

Real-World Application

While the formula method is essential for understanding the logic, professionals rarely calculate present values manually in real-world scenarios. Instead, they use:

• Excel functions like =NPV(rate, value1, value2, ...);

• Financial calculators;

• Modeling software.

However, knowing the math builds intuition. For example, you'll quickly recognize that:

• A higher discount rate makes future cash flows less valuable;

• A longer time horizon shrinks present value faster.

Discounting is the reverse of compounding. If compounding grows money over time, discounting shrinks future money to today's terms.