The choice of interest rates in project management : the case of time varying interest rates

Abstract

A study of existing and potential markets and of the technical and economical feasibility of a project, as well as sound finance planning, are indispensable. Economic profitability is the obvious and most important criteria for industrial project evaluation.The choice of interest rates in project management is the purpose of the thesis. The rate of interest should be adopted as discount rate in project evaluation. Because, the rate of interest reflects time preference and the opportunity cost of the possible alternative use of the capital invested. The interest rate is assumed to be constant during the project life in project evaluation techniques. In order to overcome this inability the constant rate should be replaced by time varying interest rates. iv Several forecast models aid project management to predict the valid interest rates in the evaluation. The thesis employs the expected-change forecast model to obtain interest rates for each year during the life cycle. An application of the model to one of the large-scale projects in the Armed Forces, namely modern self-propelled direct support artillery gun- SP2000, is presented in the thesis. Comparison of two alternative uses of interest rates in the calculation of net present value of the project is discussed. It is concluded that the constant interest rate use overstates the costs and it is suggested that the time varying interest rates should be adopted as the optimal discount rates in project management.