The interest rate that is used in discounting the cash flows of an instrument, firm or project to determine its worth reflected in the present value of its future cash flows. In other words, this rate represents the percentage reduction from the value of cash flows for each future time period.

In determining an appropriate discount rate, some relevant considerations are typically taken into account, particularly the time value of money, the risk associated with the future cash flows, and the margin of safety to compensate for an analyst’s inability to predict the future. The choice of proper discount rate will have a huge impact on the final results of calculation since a small change in the discount rate causes a large change in the value of discount cash flows. If a high discount rate is used, reflecting a high margin of safety, a lower valuation will be expected, and vice versa.

There is no an etched-in-stone method to predict future cash flows, and as quite anything in finance, it is part art (and here comes up experience) and part science.