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Discount Rates in Investment Project Evaluations

Discount Rates in Investment Project Evaluations

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This work distills the findings of 40+ years of the author’s theoretical and practical experience with the development, review and efficiency evaluation of various investment projects. Building a new plant, developing an oil field, repairing equipment - all these are the forms of investment projects. To decide whether or not to implement such a project, the company usually evaluates its efficiency with the NPV index which brings the project’s cash flows to the valuation date using discount rates (DRs). Different authors give different interpretations to the economic meaning of DRs and the target NPV. It is proposed to evaluate the efficiency of a project by relating its cash flows with the objectives and interests of the stakeholder firm. The model of optimal planning which is built for these purposes provides the link between the DRs and the financial policy of the firm and is also indicative of some alternative structures for the NPV index. When assessing different projects firms typically use different but time-invariant DRs. However, in our approach the DRs may vary in time contingent on the financial position of the firm, rather than being uniformly project-specific.
A connection to the optimal financial asset management