Your explanation of why we use a discount rate to calculate present value of future income streams is probably clearer than my clumsy effort.
However, using an inflation figure only transfers future value back to current value adjusted for inflation. The main reason for using a discount rate is that, if you did not invest your money in buying a company(say PET), you would have used the same money elsewhere and earned a rate of return. The discount rate that you apply is supposed to be a compensation for those earnings forgone had you invested elsewhere instead. So, applying a discount rate is really quite a personal thing. If I were looking to buy a company and believed that I could reasonably expect to earn 15% if I invested elsewhere, then it is reasonable to use a discount rate of 15% to calculate a Net Present Value. If the future cash flow is X and the future value of company "P" that generates that cash flow is say, $1B, then the discount rate applied tells you the value of that company in today's dollars, adjusted for what your money could have earned if you did not buy company P.
If the above calculations says that the future income stream has a NPV of $800,000,000 and I can buy it for $700,000,000 then it is a good buy. However, if the calculations say that the company has a NPV of $600,000,000 this tells me that I should invest my money elsewhere because my $7M will make more money elsewhere.
This is why Newing uses a central NPV. He is attempting to put an average investor expectancy of Return On Capital on his valuation. Some people may say that they would expect 30% return on their investment cash, others would say they would expect 6%. There is no right or wrong, just different perspectives and earnings expectations.
I am doing my head in here so I will not try to make it any clearer. Sorry if I have been unclear, it's a difficult concept to explain, especially for me. If you want to understand better and I have made it clear as mud, research NPV or get a finance lecturer to teach you.
Cheers
PET Price at posting:
$1.30 Sentiment: Buy Disclosure: Held
(20min delay)