Scheme Appraisal for Highway Projects 51
equivalent terms, substantial costs and/or benefits are unlikely to arise in the
latter years of the project. If they are predicted, the life may well have to be
extended. Truncating the analysis can also be justified on the basis of the un-
certainty with which costs and benefits that occur beyond a certain time horizon
can be predicted.
Where this technique is applied after a relatively small number of years, the
project may well have to be assigned a substantial residual or salvage value,
reflecting the significant benefits still to be accrued from the project or, con-
versely, costs still liable to be incurred by it (a residual value can be negative, as
say for a nuclear power station yet to be decommissioned). The difficulty in
assigning a meaningful residual value to a project after so few years in com-
mission results in this solution being rather unsatisfactory. It is far more advis-
able to extend the evaluation to a future point in time where the residual value
is extremely small relative to its initial value.
In addition to this, the costs and benefits occur at different times over this
time horizon. Because of this, they cannot be directly combined until they are
reduced to a common time frame. This is achieved using another parameter
introduced earlier, the discount rate,which translates all costs and benefits to
time equivalent values. The actual value used is the social discount rate, given
that the decision-maker is interested in the benefits and costs to society as a
whole rather than to any individual or group of individuals.
The setting of this rate is quite a complex process, and is somewhat beyond
the scope of this text. It is important to point out, however, that it is not the
same as the market interest rate available to all private borrowers. It is a collec-
tive discount rate reflecting a project of benefit to a large number of people and
spanning a time frame greater than one full generation. A single definitive dis-
count rate does not exist. Its estimation can be based on time preference or the
opportunity cost of resources. The first is based on people in general having a
preference for development taking place now rather than in the future. Because
this involves taking a long-term view, the social time preference rate is usually
set at a low, single-figure rate. The second reflects what members of society have
foregone as a result of funds being devoted to the development in question. The
prevailing real interest rate is often used as a guide for this value. Typical rates
can reach 15%, appreciably higher than the figure obtained from the time
preference approach. Economists will have varying views about the most appro-
priate test discount rate to use. In many instances the main decision-maker or
the person financing the proposal will set the rate. Before doing so, discussions
with all relevant stakeholders may be appropriate.
3.3.5 Use of economic indicators to assess basic economic viability
Once the two parameters of project life and discount rate are set in place,
these allow all costs and benefits to be directly compared at the same point in
