Optimal Discount Rates for Government Projects

Abstract

Project selection based on the net present value can be optimal only if the discount rate is optimal. The optimal discount rate for a government project can be a risk-free rate, a comparable market rate (market interest rate corresponding to the risk of cash flows to the government), or an adjusted market rate, depending on circumstances. This paper clarifies the conditions for each case. Provided that the optimal discount rate is the comparable market rate, it varies across intervention methods and changes with the subsidy rate.