What is discount rate?

A discount rate is the percentage used to shrink a future amount of money into its value today. It stands for the return you could earn on an alternative use of the money, plus compensation for the risk that the payment does not arrive. Choosing it well matters because it often decides whether a long-term project looks worthwhile or not.

How it works

Discounting works like compound interest in reverse. If money grows at rate r per period when invested, then an amount F arriving in n periods is worth F / (1 + r)^n today. The higher the rate, the lower the present value, and the effect grows with distance in time, so payments far in the future are cut most heavily.

There is a real trade-off in picking the number. A low rate favors projects with long, slow payoffs. A high rate favors quick returns and punishes patience. Many teams set the rate from their cost of capital and add a premium for riskier projects, and then test how the decision changes if the rate moves a few points either way.

Example

Say a supplier promises to pay 1,000 in two years. At a 5% discount rate, that promise is worth 1,000 / 1.05^2, about 907 today. At 15% it is worth 1,000 / 1.15^2, about 756. The same promise looks 150 poorer only because the rate is higher. If you were comparing it with an offer of 800 today, the 5% rate says wait and the 15% rate says take the cash. This is an illustration with round numbers.

How to model it in Machinations

Put the discount rate on a Register and expose it as a Lever. Create a Pool of future payments, and a Register for each payment's present value that divides it by (1 + rate) to the power of the step number. Chart the sum of present values. Play with the Lever at several settings, and add a Gate that makes the payment arrive only some of the time if you want to see how risk and discounting combine across many Plays.