Question

Which of the following rate should be used for discounting a provision?

a. A post tax rate that is risk free.
b. A post tax rate adjusted for risks specific to the liability.
c. A pre-tax rate which reflects risks accounted for in future cash flow estimates.
d. A pre-tax rate that reflects the markets assessment of the time value of money.

Answer 1

The rate that should be used for discounting a provision is a pre-tax rate that reflects the market's assessment of the time value of money.

Step-by-step explanation:

The rate that should be used for discounting a provision is a pre-tax rate that reflects the market's assessment of the time value of money.

The present discounted value (PDV) is a widely used analytical tool in finance. Businesses often use it when making physical capital investments to compare the present costs to the present discounted value of future benefits. The pre-tax rate is used because it captures the market's perception of the time value of money without considering any tax implications.

For example, let's say a business is considering making an investment that will have future benefits of $1,000. The market's assessment of the time value of money is 8% per year. Using the pre-tax rate, the present discounted value of these future benefits would be calculated as follows: PDV = $1,000 / (1 + 0.08) = $925.93.