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analysis should be consistent with the form of a92 cash flows. To summarize, red discount rates and constant dollar cash flows exclude inflation, whereas nominal discount rates and current dollars include inflationary effects. A current dollar mdysis requires the use of a nominal discount rate, and a constant dollar analysis requires the use of a real discount rate. ~ Discount rates can be converted from real to nominal, and vice versa, with the following formula: (I+d,) =(1+dJ(1+e) an = [(l+d,)(l +e)] - 1 (2-3) =[(I+61,) /(1+e)]-1 = discount rate in the absence of inflation (red) e = inflation rate. Where: d,, = nominal discount rate 4 df For example, given aninflation rate of 6% and a nominal discount rate of lo%, a red discount rate of 3.77% is calculated using the above formula2 Reca3l that the discount rate is a measure of time value. This time value or cost of money is not necessarily the same for all investors. The discount rate will be influenced or determined by a wide variety of factors, such asthe investor’srate of return, risk premium, planning horizon, interest rates, and incomeandpropertytaxes. Discountrateswillvaryfromstatetostate,industrytoindustry,andcompany to company. In Circular No. A-94 (OMB 1992 revised January 1995), the Office of Management and Budget ( O m ) has established discount rate guidelines for use when evaluating ule cost-effectiveness of internal governmentinvestments. AppendixCofthecircularlistsrecommendeddiscountratesforshort-andlong- term projects. These rates, presented in Table 2-2, are based on U.S. Treasury borrowing rates and are updated annually? Analyses of programs with terms different from those presented below may use a linearinterpolation. Also,projectswithtermslongerthan30yearsmayusethe30-yeardiscountrate. Office of Management and Budget Recommended Discount Rates (January 1995-February 1996) I~~~ ~ Real Nominal Table 2-1. 3-Year 5-Year 4.2% 4.5% 7.3% 7.6% 30-Year I n addition, the federal government annually sets a discount rate for use when evaluating federal projects in which one of the primary purposes of the project includes conservation or renewables. The rate is 2A reasonable approximation is realized by assuming 41 = 4 + e. For this example en, the approximate real discount rate is 4. = 10% - 6% = 4%- 30MB Circular A-94 also dictates the use of a real discount rate of 7% (based on the average private sector return on investment before taxes) for the evaluation of regulatory programs and public investment; i.e., for investments that benefit the general public (such as a new highway). 6 7-Year 10-Year 4.6% 4.0% 4.9% 7. 7Oh 7.9% 8.1%PDF Image | A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies
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