Discount rate

The discount rate is also sometimes called an interest rate, but it works in reverse of the operation we usually perform with interest rates. Interest rates are used to determine the value, at some future date, of an investment made in the present. For example, \$50 invested now at an annual interest rate of 10% will be worth \$55 in one year: \$50 + (\$50*10%) = \$50 + \$5 = \$55.

Discount rates are used to determine the value in today's dollars of money paid or received at some future time. For example, if we are promised a payment of \$55 in one year and the discount rate is 10%, the present value of that payment is \$50.

This calculation is used in cost-benefit analysis in order to put all the economic flows of a project, which occur at different points in time, in a single year's currency, so that the costs and benefits can be compared. See the help article on Net Present Value to learn how this operation is done.

There are different versions of the discount rate:

Nominal v. real: the nominal discount rate includes inflation and the real discount rate does not.

Financial v. economic: the financial discount rate is that which applies to analysis done from a private investor's point of view. It considers actual cost of borrowing and actual returns on alternative investments in the market, which may be subject to distorting policies such as taxes and subsidies or market failures such as monopolies. The economic discount rate is a measure of how a whole society values future v. present consumption. An economic discount rate is used in this version of the HydroCalculator, which focuses on economic, not financial analysis.

If you are unsure of the correct economic discount rate to use, you might consult the World Bank or the government of the country in question. The rates used are typically close to 10%, but try your analysis with other rates between 5% and 15% to determine whether the project's feasibility is sensitive to the discount rate.