The document discusses the concept of time preference, which is the valuation of receiving goods or cash sooner rather than later, influenced by both neo-classical and Austrian economic theories. It explains temporal discounting, the practice of valuing immediate rewards more highly than future ones, alongside the role of discounting in evaluating present value of future cash flows. Additionally, it outlines different types of discount rates used in corporate finance and the implications of positive, negative, and zero time preferences on investment decisions.

1. Presentation Time Preference and
Discounting
SUBMITTED BY;
AHMAD SHERAZ(13038)

2. Time Preferences

3. Time preference
• What is time preference?
• Views of Economists:
• Neo-classical views.
• Austrian school views.
• Temporal discounting.
• Examples.

4. What is time preference?
• Time preference is the current relative valuation placed on receiving
a good or some cash at an earlier date compared with receiving it at
a later date.
• Time preferences are captured mathematically in the discount
function. The higher the time preference, the higher the discount
placed on returns receivable or costs payable in the future.

5. Neo-classical views.
• In the neoclassical theory of interest due to Lrving Fisher the rate of
time preference is usually taken as a parameter in an
individual’s utility function which captures the trade off between
consumption today and consumption in the future.

6. Austrian school views.
• In his book Capital and Interest, the Austrian economist Eugen von Böhm-Bawerk built upon
the time-preference ideas of Carl Menger, insisting that there is always a difference in value
between present goods and future goods of equal quality, quantity, and form. Furthermore,
the value of future goods diminishes as the length of time necessary for their completion
increases.
• George Reisman says that time preference arises because of the possibility of being less able
or totally unable to enjoy the use of goods in the future. The further into the future someone
considers, the less likely it is that this someone will be able to enjoy the goods as much as
they can be enjoyed now.

7. Temporal discounting.
• Temporal discounting is the tendency of people to discount rewards as they approach a
temporal horizon in the future or the To put it another way, it is a tendency to give greater
value to rewards as they move away from their temporal horizons and towards the "now".
For instance, a nicotine deprived smoker may highly value a cigarette available any time in
the next 6 hours but assign little or no value to a cigarette available in 6 months.

8. Example
• A practical example is if Jim and Bob go out for a drink and Jim has no money so Bob lends
Jim $10. The next day Bob comes back to Jim, and Jim says, "Bob, you can have $10 now, or
at the end of the month when I get paid I will give you $15." Bob's time preference would
change depending on if he trusted Jim and how much he needs the money now, thinks he
can wait, or would prefer to have $15 at the end of the month than $10 now. Present and
expected needs, present and expected income affect the time preference.

9. Discounting.

10. What is discounting?
In relation to the time value of money, which argues that a dollar today is worth more than a
dollar tomorrow, discounting can be defined as the act of estimating the present value of a
future payment or a series of cash flows that are to be received in the future. Discounting is a
key element in valuing future cash flows.

11. Discount Rate:
A discount rate (also referred to as the discount yield) is the rate used to discount future cash
flows back to their present value. In corporate finance, cash flows are normally discounted at a
company’s weighted average cost of capital. its hurdle rate, or the required rate of return. The
hurdle rate is the return that investors anticipate concerning the risk associated with the
investment they have made.

12. Formula
• To derive a discounted value or the present value,
the following equation can be used:
 FV is used to denote the
future value of cash flow.
 r is used to denote the
discount rate.
 t is used to denote the time
period that an investment
will be held for.
The present value can also be the sum of all future cash flows
discounted back. It is known as the Net Present Value.

13. Types of Discount Rates
The types of discount rates commonly used in corporate finance include:
•Weighted Average Cost of Capital: Normally used to compute a company’s enterprise value.
•Cost of equity: Can be used to calculate a company’s equity value.
•Cost of debt: Used for bond and fixed-income security valuation.
•A pre-defined hurdle rate: Generally used in evaluating corporate projects that are internal
and to account for the time value of money
•Risk-free rate: Used in calculating the cost of equity.

14. Positive Time Preference as Basis for Discounting
A consumer is said to have positive time preference if he is unwilling to exchange an extra
quantity of consumption now for an extra quantity later unless the amount of consumption later
were larger. Negative time preference entails the willingness to sacrifice a unit of consumption
now for less than a unit later. Zero time preference can be defined in a similar way.
If positive time preference turns out to be a systematic human tendency it means that people
naturally discount future consumption, and this should be sufficient justification for discounting
future benefits and costs of investment
• It should be noted that the assumption of positive time preference has been used, since Bohm-
Bawerk, as one explanation of, and justification for, the existence of a positive rate of interest.

15. Assumption of Positive Time Preference
The basic justification for assuming positive time preference can be traced back to Bohm-Bawerk who
thought that “If the marginal utility of future goods is lower because of their increased provision, present
goods must be preferred”
If income and consumption per head in an economy are growing, the representative person usually
expects the marginal utility of consumption at some future point of time to be less than it is at present.
Accordingly, if he is asked to sacrifice present consumption in return for extra consumption in the future,
he would require future consumption to be larger, i.e. he would discount it.As for those individuals who
expect their income to fall through time, it would be advantageous for them to save even without the
prospect of larger future consumption. But on a weighted average, such individuals are a minority in a
progressive economy.
The Case for PositiveTime Preference