Why does interst cost decrease as we increase the discount rate? I f interst cost =PBO x discount rate wouldn’t that increase it? For some reason I can’t wrap my head around the offsetting. Thanks.
As discount rate increases, your PBO decreases (PV value of future pension pmts).
Normally, the decrease of PBO has a larger effect than the increase on discount rate, therefore, your interest cost decreases.
Yes, if ur firm is not new (very low PBO).
Thanks, I understand why PBO decreases when disco in rate increases but maybe I’m thinking about this the wrong way
i.e PBO 100 x Discoint rate 10% = 10 interest cost
if discount rate is 15% than PBO 100 x 15% = 15 interst cost (higher)
i totally understand that PV of future payments is lower from higher discount rate, but looking at interst cost alone haven’t they gone up? Not sure why I can’t wrap this around my head…
As discount rate increases, your PBO decreases (PV value of future pension pmts) - you can think this as a big money with your example like 10,000 that will make the presnet value not 100 but somethign different like 80 then 18*15% will eb less t han 15.
Normally, the decrease of PBO has a larger effect than the increase on discount rate, therefore, your interest cost decreases - so the interset cost wil be using this smaller figure and hence the intrest cost deccreases.
We use the same discount rate to calcualte the itnrest cost and the discoutign factor, whicv means the cost by which PBO increases each year and cost that is used to discount the big chunk of money in the future remains the same.
Hence the effec tis less.
Got it! Thanks all!