Topic 7.1: Financial Discount Rates and Calculation of Net Present Value (NPV)

A major impediment to the application of silvicultural treatments is that the benefits are enjoyed long after the costs are borne, and people prefer to receive the benefits sooner rather than later. This “time value” of money (i.e., benefits) is referred to by economists as the “discount rate.” Knowing the discount rate and the timing of expenditures allows calculation of the “net present value” (NPV) of an investment as:

For a discount rate of 0, regardless of the time horizon, the NPV is the arithmetic total of financial costs and benefits. Some people quite reasonably argue that in the interest of inter-generational equity, the future shouldn’t be discounted, but most in a capitalistic system, discount rates are typically assumed to be positive. For example, at a discount rate of 10% (the denominator is 1.10), $1100 received in one year has an NPV of only $1000. As the discount rate increases, the value (as the NPV) of income in the future declines.