A highway project is often complex and long term, with the costs and benefits associated with it occurring over a long time frame which we term the life of the project, a parameter dealt with in earlier chapters. It sets a limit on the period over which the costs and benefits are estimated, as all must occur within this time slot, be it 25, 35 or even 50 years or more. It is related, in principle, to the expected lifetime of the project under analysis.
Given that transport development projects have the potential to be in service for a very long time, it may seem impossible to set a limit on the life of the project with any degree of certainty. In practice, however, this may not give rise to serious problems in the evaluation, as the loss of accuracy that results from limiting the life of a project to 35–40 years, instead of continuing the computation far beyond this point, is marginal to the analyst undertaking the evaluation. The shortened analysis can be justified on the basis that, in time 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 uncertainty 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, conversely, 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 commission results in this solution being rather unsatisfactory. It is far more advisable 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 collective 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 discount 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 appropriate 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.
