Discount rate/Tutorials

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Tutorials relating to the topic of Discount rate.

The Ramsey equation

The social time preference rate, s, is given by:-

s = δ + ηg

where:

δ is the pure time preference rate (otherwise known as the utility discount rate);
η is the elasticity of marginal utility with respect to consumption; and,
g is the expected future growth rate of consumption.


Evidence based upon the structure of personal income tax rates in OECD countries suggests that the value of η for most developed countries is close to 1.4 [1]. By Evans, David J Fiscal Studies 2005 ]</ref>. Estimates for the United Kingdom have ranged from 0.7 t0 1.5. [2].


The present value of future cash flows

The present value V of a cash flow occuring after an interval of t years at a dicount rate of r is given by:


The net present expected value of a future cash flow that has z possible values is given by calculating the value of in the above equation as:

where is the probability of occurrence of the value


The present value of a series of annual cash flows after annual intervals 0 to n is given by:

.

References