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Choice of the discount rate

Choice of the discount rate

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It needs to be explained that there are two discount rates. The first is discount rate for investment (or goods). This is a concept that measures the relative price of goods at different points of time. This is also called the real return on capital, the real return and the opportunity cost of capital. This is what we shall be dealing with in this chapter. The second is the discount rate that involves long-term environmental considerations. This measures the relative weight of the economic welfare of different generations over time. This is usually called the 'pure rate of social time preference'. This will be utilised in Chapter 8 for evaluating environmental and global warming considerations.

Chapter Contents:

  • 4.1 Introduction
  • 4.2 The discount rate
  • 4.3 Calculating the discount rate
  • 4.3.1 Government financed projects
  • 4.3.2 Business investment projects
  • 4.3.2.1 The risk-free rate of interest
  • 4.3.2.2 Premium to compensate for risk
  • 4.3.2.3 Taxation and its relationship with the discount rates
  • 4.3.2.4 Inflation
  • 4.4 Controlling the value of the discount rate
  • 4.4.1 Capital structuring
  • 4.4.2 Transferring risk
  • 4.5 Other forms of the discount rate
  • 4.5.1 Weighted-average cost of capital
  • 4.5.2 Utilisation of multiple discount rates
  • 4.6 Summary
  • References

Inspec keywords: financial management; investment; electricity supply industry; socio-economic effects

Other keywords: environmental considerations; goods relative price measurement; discount rate; pure rate of social time preference; real return on capital; economic welfare; investment; opportunity cost of capital

Subjects: Power system management, operation and economics

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