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Showing posts with label CBA. Show all posts
Showing posts with label CBA. Show all posts

6/15/18

How to choose a discount rate--and justify it

11:12
How to choose a discount rate--and justify it

In general there are three possible justifications for choosing a discount rate for your cost benefit analysis. The three justifications are used to explain how people perceive costs and benefits affecting them in different time periods. Because there are a lot of mechanisms within an economy that account for valuing money in different time periods (the most obvious is the interest rate on loans, but inflation and other factors can play a role) they tend to be the predominate choice when choosing a discount rate. The three most common justifications for discount rates are:

1) Cost of borrowing funds. The first and most appropriate justification for choosing a discount rate would be the cost of borrowing the money or capital to run a project. This justification makes the most sense if you are actually going to borrow funds to complete your project. In this scenario you would want your benefits to grow at a rate faster than the interest rate on the loan you made to make the project possible.