Discount rates for long-term projects: The cost of capital and social discount rate compared

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Abstract

Research on the cost of capital and on the social discount rate (SDR) has developed largely along separate paths. This paper offers an overview and comparison of both concepts. The consumption-based theory of discount rates is common to both, but there are striking differences in how the cost of capital and SDR are estimated. A project’s cost of capital is inferred in practice from market data, by a well-established package of techniques, and project risk makes a large difference. In contrast, the SDR is estimated by applying judgement about the welfare of future generations, in the setting of consumption-based theory. Project risk has tended to be ignored under the SDR approach.
Original languageEnglish
Pages (from-to)60-79
Number of pages20
JournalThe European Journal of Finance
Volume23
Issue number1-3
Early online date22 Apr 2015
DOIs
Publication statusPublished - Jan 2017

Keywords

  • cost of capital
  • social discount rate
  • consumption based theory
  • risk premium
  • declining discount rate
  • G31
  • H43
  • G12

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