The discount factor will usually be derived from the hurdle rate that the company sets which determines whether a potential project will be acceptable or not (this is along the lines but somewhat different to what FC was referring to above as "largely risk free"). If the normal/ core business of a company returns say 10%pa & 2 potential projects A & B are each estimated to give an annualised rate of return over the same projection period (& given the same risk to capital) of say 9% & 11% resp., then all things considered only B would be chosen. Project A wouldn't be chosen as the capital involved could be earning 10% in the normal business...
The DF will be set depending on a number of factors such as say capital strain, inflation & interest rate conditions, exposure to risk, project term, BE point, business requirements, etc., etc.
In your above example the DF looks like it's derived from a hurdle rate of 8%, where the discount factor is calculated as:
DF
= [1/(1+Hurdle Rate)]^n
so for cashflow on the 1st anniv the DF would be (1/1.08)^1 = 0.926, on the 2nd anniv it would be (1/1.08)^2 = 0.857.....
Taking a simple example of a 100k goverment bond redeemed @ par in 5 years paying 10% coupons the NPV (using a hurdle rate of 8%) of all the cashflows would be;
NPV = -100000+10000*DF(1)+10000*DF(2)+10000*DF(3)+10000*DF(4)+10000*DF(5)+100000*DF(5)
NPV = 7985
You can see that this "project" would be viable as under the hurdle rate the net present value (i.e the discounted future profit) is positive. The +ve result above should be naturally expected as the coupon rate is greater than the hurdle rate & we assumed purchase at issue (& therefore at par), however if purchase was not at issue & the price most likely not at par then it would be a more applicable exercise....
