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Should CBA use descriptive or prescriptive discount rates? It should use both!

Szekeres, Szabolcs (2021): Should CBA use descriptive or prescriptive discount rates? It should use both!

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Abstract

Discounting project net flows that exclude financing costs with prescriptive rates fails to reflect costs of capital; discounting them with descriptive rates fails to reflect intertemporal preferences. A hybrid discounting method is proposed by which descriptive rates are used to forecast costs of capital and prescriptive rates are used to discount all-inclusive net welfare flows. An agent-based capital market model audits the performance of alternative discounting approaches. There is no need to reconcile the discounting approaches. They should be viewed as complementary, not as competing. For projects to be economically feasible their rate of return should exceed both the STPR and the SOCR. Following this rule will ensure that proposed public sector projects will be no less effective at converting present consumption into future consumption than what the public can already manage and that the benefits of proposed projects will exceed all their direct and indirect costs.

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