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Last edited 27 Nov 2020
Discounting for construction projects
Discounting is a way of comparing the value of costs and benefits over different time periods to their present values. It provides a means for accurately assessing the economic impact of a project over time and helps to calculate net present value (NPV - the difference between the present value of cash inflows and the present value of cash outflows for a long-term investment that can be used to assess the likely profitability of investments).
The principle of discounting is based around the time value of money. This is the concept that money is worth less in the future than it is in the present because of its reduced capacity for generating a return, such as interest, and because of inflation. Discounting is a means of assessing how much less an amount is worth in the future than it is now.
- End of year 1 = £120,000.
- End of year 2 = £250,000.
- End of year 3 = £550,000.
- End of year 4 = £1.3m.
120,000/1.05¹ = £114,285.70 (Year 1).
250,000/1.05² = £226,757.37 (Year 2).
550,000/1.05³ = £475,110.68 (Year 3).
1,069,512.22/1.05^4 = £1,069,513.22 (Year 4).
NPV = £1,885,666.97
NPV = £1,885,666.97 – £1.7m
NPV = £185,666.97
120,000/1.1¹ = £109,090.91 (Year 1).
250,000/1.1² = £206,611.57 (Year 2).
550,000/1.1³ = £413,223.14 (Year 3).
1,069,513.22/1.1^4 = £887,917.49 (Year 4).
NPV = £1,616,843.11
NPV = £1,616,843.11 – £1.7m
NPV = -£83,156.89
In this scenario there does not appear to be economic justification for the project to go ahead.
NB The Green Book, Central Government Guidance On Appraisal And Evaluation, Published by HM Treasury in 2020, suggests discounting: ‘…is a technique that converts future values occurring over different periods of time to a present value by taking account of the human preference for value now rather than later. This concept is known as “social time preference”, and it is applied to real prices expressed in base year values and has nothing to do with inflation.’
The SuDS Manual published by CIRIA in 2015 defines discounting as: ‘A method to compare the benefits and costs that arise over the appraisal period. The discount rate converts all costs and benefits to the present day to determine the present value (PV) or whole life costs (WLC) so that they can be evaluated consistently.’
 Related articles on Designing Buildings Wiki
- Base year.
- Cash flow.
- Compound Annual Growth Rate (CAGR).
- Cost-benefit analysis in construction.
- Discounted cash flow.
- Discount rate.
- Gross value added (GVA).
- Internal rate of return for property development.
- Life cycle assessment.
- Life Cycle Costing BG67 2016.
- Net present value.
- Payback period.
- Time value of money.
- Whole life costs.
 External references
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