Discounting (present value)

Discounting is the mathematical operation of converting future cash flows or values into their present equivalent, by dividing them by a factor that reflects the time value of money and the associated risk. It is the core mechanism of all intrinsic valuation methods (DCF, dividend discount model, excess earnings) and of any calculation requiring the present value of future obligations (pension liabilities, lease commitments, contingent payments). The discount factor is 1/(1+r)^n, where r is the discount rate and n the number of periods. The higher the discount rate or the longer the time horizon, the lower the present value of future amounts. Discounting is the inverse of compounding: in company valuation, the discount rate typically corresponds to the weighted average cost of capital (WACC) for cash flows to the firm, or to the cost of equity for cash flows to shareholders.

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Example: a company expects to receive CHF 5.0 million in 5 years under an earn-out arrangement. Discounted at a rate of 8.0% (reflecting the risk that the earn-out condition may not be met), the present value at closing is CHF 5.0 / (1.08)^5 = CHF 3.40 million, the amount recognised as part of the acquisition price in the IFRS 3 purchase price allocation.

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At Hectelion, discounting is applied rigorously in every valuation context, from DCF models to earn-out present value calculations and pension liability assessments.