Key Parameters for Economic Evaluation: Time Horizon and Discount Rate

Large, long-lived, rapid transit infrastructure investments shape the development of the city
and its economy for generations. Standard economic analysis tools are not able to
accommodate this adequately—after about 20 years, all benefits are discounted to virtually
nothing. Therefore, the choice of evaluation horizon and discount rate can have a large impact
on the results of the analysis and must be chosen carefully to address the value from projects
that accrue to future generations.

Evaluation Horizon or Time Period

Since benefits and costs are summed over future years, the evaluation horizon can affect the
outcome of the economic and financial analysis. The evaluation horizon starts with the first
expenditures and extends through the useful life of the alternative or some future time at which
meaningful estimates of effects are no longer possible. Formally, the planning horizon must be
equal to the economic life of the longest-lived option included 
 among the alternatives being
evaluated. Normally, urban rail alternatives are the longest lived. Therefore, other shorter-lived
rapid transit alternatives may need to account for multiple capital investment cycles during the
longer evaluation period dictated by the inclusion of an urban rail alternative. In general,
economic evaluation for rapid transit alternatives should account for benefits and costs for a
50-year period and include residual benefits for even longer-lived assets in line with the long-
term vision for the city.

For example, we can illustratively compare cash flows for hypothetical bus rapid transit (BRT)
and urban rail investment alternatives over a 50-year evaluation horizon (see Figure R3). For
the BRT alternative, many of the infrastructure components will need to be replaced, requiring
significant capital re-investment within the longer evaluation horizon. In contrast, the urban
rail system will not require a full reinvestment as long as assets are maintained each year.
Figure R3. Illustrative Net Flow of Benefits and Costs for a BRT and an Urban Rail
Alternative over a 50-Year Evaluation Horizon

Note: The numeric values for costs and benefits associated with urban rail and BRT are system-
and context- dependent, so the vertical axes representing costs are not to the same scale in each
panel. BRT = bus rapid transit; O&M = operation and maintenance.

Social Discount Rate. In addition to the evaluation time horizon, another important assumption
that affects the cash flows of the alternatives and, therefore, their economic and financial
evaluations is the choice of social discount rate. The social discount rate is used to express
future benefits and costs in present value terms. Discount rates are widely used in economics to
reflect the fact that money in the future tends to have less value than money today and the fact
that up-front costs are often more salient than future benefits. The discount rate reflects the
value of money considering the opportunity cost of investing in the particular project instead of
elsewhere. The discount rate has to be adjusted to consider expected inflation; in this way,
standard economic analysis links social discount rates to the long-term growth prospects of the
project’s country.

High discount rates reflect a higher value for returns and costs today than for returns and costs
in the future. This tendency usually penalizes projects such as urban rail and other
transportation infrastructure development that involve high investments at the beginning of
the project, with all expected returns materializing in the future over a long system lifetime. For
this reason, a high social discount rate is not recommended for large-scale public infrastructure
projects such as most urban transportation alternatives (Lopez 2006; Weitzman 1998). As the
discount rate falls, projects with benefits emerging in the long run become more attractive.
Thus, public investment programs can be dramatically different depending on the specific
discount rate used in practice.

In the past, World Bank infrastructure projects often assumed a 12 percent discount rate when
calculating economic and financial internal rates of return. However, a much lower rate,
between 4 and 8 percent, has been observed recently for large public transport projects with
long-lived benefits. Some countries have moved toward using a declining discount rate for
projects, like urban rail developments, with broad impact and long-term benefits. For example,
in analysis of public policies and public investments, the official analytical guidelines of the U.K.
government specify a discount rate structure that decreases over time (see Table R3). In France,
the official discount rate is 4 percent for a 30-year period, decreasing to 2 percent over time
(World Bank 2016).

Table R3. Discount Rate Structure in the Official Guidelines of the United Kingdom (HM
Treasury 2003, 97-100)

PERIOD (NUMBER OF YEARS) DISCOUNT RATE (%)

0–30 3.5
31–75 3.0
76–125 2.5
126–200 2.0
201–300 1.5
301+ 1.0

References:
HM Treasury. 2003. The Green Book: Appraisal and Evaluation in Central Government. London:
HM Treasury.
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file
/220541/green_book_complete.pdf

Lopez, Humberto. 2006. “The Social Discount Rate: Estimates for Nine Latin American
Countries.” Policy Research Working Paper 4639, World Bank, Washington, DC.
https://openknowledge.worldbank.org/handle/10986/6659

World Bank. 2016. “Discounting Costs and Benefits in Analysis of World Bank Projects.”
Operations Policy and Quality Department (OPSPQ) Guidance Note [for internal use
only], World Bank, Washington, DC.

Wright, Lloyd, and Karl Fjellstrom. 2003. “Module 3a. Mass Transit Options.” In Sustainable
Transport: A Sourcebook for Policymakers in Developing Cities. Frankfurt: GTZ (Deutsche
Gasellschaft für Technische Zusammenarbeit), GmbH.
https://www.itdp.org/wp-content/uploads/2014/07/Sustainable-Transport-Mass-
Transit-Options.pdf