The Discount Rate in the Evaluation of Project Economic-Environmental Sustainability

Abstract

The debate about project economic sustainability evaluation from a life cycle perspective focused on the conventional Life Cycle Costing (LCC). Despite the potentialities of the approach for evaluating design options at different scales (building/system/component/material), some limits emerge due to the neoclassical nature of the economic principles on which it is founded. The most important aspect of this debate is the necessity to clarify how to deal with environmental costs in the calculation, particularly in the case of public/PPP interventions. Two research topics emerge for strengthening the capability of LCC to deal with environmental components: (1) the LCC and environmental quantitative analysis (using Life Cycle Assessment) joint application; (2) the integration of the environmental dimension into the microeconomic approach, using appropriate discount rates. As known, these last are particularly relevant for public projects, in which the time value of money issue becomes crucial in presence of long lifespan analyses and economic objectives. Thus, the purpose of this paper is to explore alternative discounting modalities, for identifying the preferable one, towards an “environmental LCC model”. The research domain is therefore on the limits of LCC in dealing with environmental cost components, at the time being poorly studied by the scientific literature: this point represents the missing link which form the basis for the research problem to be addressed. The research design is focused on the investigation of environmental hurdle rate technique and the escalation rate approach, as alternatives to the standard “time preference” (financial) one. The LCC and the global cost are selected as the main tool for the analysis, which is founded on an empirical research methodology. The results, obtained by simulations on a case study (two alternative technological components), confirm the relevance of the discount rate effect on the Global Cost calculation by modelling some of the potential impacts of building components on the environment, e.g., the expectations of technological development over time. By the environmental hurdle rate, the results can even change the final preferability ranking obtained using financial rates. The value of the work consists of growing the debate on the topic and supporting environmentally responsible investment decisions in the building construction sector (new-build/retrofit of existing assets).

Building upcycling or building reconstruction? The ‘Global Benefit’ perspective to support investment decisions for sustainable cities

“…Moreover, r' represents the financial or market rate and r" represents the 'hurdle rate. ' Notice that the use of different discount rates-the conventional 'time preference' or financial rate and the 'environmental hurdle rate'-is due to the capacity of the latter to model the expectations of future knowledge-e.g., on technology development, as illustrated in previous studies (Pearce and Turner, 1990;Gray et al, 1993;Fregonara and Ferrando, 2023). This last, crucial point confirms the perspective nature of the line of reasoning.…”

Discounting the Distant Future: What Do Historical Bond Prices Imply about the Long-Term Discount Rate?

“…The 2% is very close to the 1.4% from the Stern report [2], which has been criticised for being too low. The results presented here seem to support the Stern discount rate and this low value has important implications for many aspects of our societies (e.g., energy policy [56], insurances [57], and environmentally responsible investment decisions [58]). The higher values reported by other authors do not seem to be fully consistent with the historical data and the analysis performed here.…”