Explain why it is necessary to discount a future income stream to determine it's present value?

Answer 1

To answer this question, ask yourself this question: would you rather have $100 today or $100 one year from today? How about $100 today or $105 one year from today? $100 today or $200 one year from today? If you ask questions like that to a group of people, you can estimate the average discount rate fairly effectively.

In the case of the individual, waiting for income delays the utility provided by the consumption of goods or services that income can provide, and most people would rather have consumption sooner, so they can derive utility for longer amounts of time.

In the case of the firm, there is a time value to money. At the very least, money can be invested in government T-bills, guaranteeing a rate of return. If two investments have the same guaranteed return, but one will have a return five years before the other, a firm would, ceteris paribus, prefer the faster-repaying investment, because they could invest the money in a T-bill for five years and be better off. (Or, more likely, make additional investments.)