INTEREST AND THE RATE OF RETURN ON INVESTMENTS

THE INTEREST RATES USED IN MOST ECONOMY STUDIES FOR HIGHWAYS AND OTHER PUBLIC WORKS HAVE BEEN QUITE LOW FOR MANY YEARS. THE 1958 REVISION OF THE GREEN BOOK (PROPOSED PRACTICES FOR ECONOMIC ANALYSIS OF RIVER BASIN PROJECTS) SAYS THAT THE INTEREST RATE APPROPRIATE FOR USE IN PROJECT EVALUATION FOR CONVERTING ESTIMATES OF BENEFITS AND COSTS TO A COMMON TIME BASIS IS A RISK-FREE RETURN EXPECTED TO BE REALIZED ON CAPITAL INVESTED IN ALTERNATIVE USES. THE VIEWPOINT REQUIRES THE USE OF SUBSTANTIALLY HIGHER INTEREST RATES FOR ECONOMY STUDIES FOR PUBLIC WORKS, PARTICULARLY IN ECONOMY STUDIES FOR HIGHWAYS. ECONOMY STUDIES COMPARING ALTERNATE PROPOSALS FOR INVESTMENT MAY BE MADE BY SEVERAL DIFFERENT MEANS: (1) COMPUTE THE PROSPECTIVE RATE OF RETURN FOR EACH PROPOSAL AND JUDGE PROPOSALS IN RELATION TO ONE TO ANOTHER OR RELATION TO SOME STIPULATED MINIMUM ATTRACTIVE RATE OF RETURN, OR (2) USE OTHER METHODS APPLICABLE TO CERTAIN TYPES OF ALTERNATIVES, TO CONVERT TO EQUIVALENT UNIFORM ANNUAL COSTS OR TO PRESENT WORTH. IN EVALUATING PROPOSED PUBLIC WORKS, THE MOST COMMON METHOD IS TO COMPARE BENEFITS WITH COSTS. HOWEVER, IT IS ESSENTIAL TO RECOGNIZE THAT THE ISSUE OF WHAT OUGHT TO BE THE MINIMUM ATTRACTIVE RATE OF RETURN, ALL THINGS CONSIDERED, IS STILL PRESENT WHEN DECISION-MAKING IS BASED ON COMPARISONS OF ANNUAL COSTS, COMPARISONS OF PRESENT WORTH, OR ON AN ANALYSIS OF BENEFITS AND COSTS. THE YIELDS ON INVESTMENT OPPORTUNITIES OUTSIDE OF THE HIGHWAY FIELD SEEM TO BE CLEARLY RELEVANT IN SETTING A MINIMUM ATTRACTIVE RATE OF RETURN FOR PROPOSED HIGHWAY IMPROVEMENTS. IT SEEMS THAT THE CASE FOR HIGHER MINIMUM ATTRACTIVE RATES OF RETURN IN ECONOMY STUDIES FOR PROPOSED HIGHWAYS SHOULD BE BASED PRIMARILY ON THE FOREGOING CONSIDERATIONS RELATIVE TO OPPORTUNITY COSTS. SEVERAL OTHER ASPECTS OF THIS TOPIC ARE: (1) THE CONSIDERATION THAT SHOULD BE GIVEN TO RISK IN SELECTING A MINIMUM ATTRACTIVE RATE OF RETURN FOR PROPOSED HIGHWAY INVESTMENTS, (2) THE SENSITIVITY OF DECISIONS TO DISTANT FORECASTS IN CASES WHERE A LOW MINIMUM ATTRACTIVE RATE OF RETURN IS USED, (3) THE POINT THAT THE COST OF MONEY BORROWED BY GOVERNMENTS OFTEN IS SOMEWHAT GREATER THAN IT APPEARS TO BE, (4) THE RELATIONSHIP BETWEEN THE SELECTION OF A MINIMUM ATTRACTIVE RATE OF RETURN AND THE UNEVEN UNFAVORABLE CONSEQUENCES OF MANY PUBLIC WORKS, AND (5) THE RELATIVE MERITS OF THE RATE-OF-RETURN TECHNIQUE AND THE BENEFIT-COST TECHNIQUE FOR EVALUATION OF PROPOSED HIGHWAY IMPROVEMENTS. IT IS CAUTIONED THAT THE INTEREST RATE DOES NOT ALWAYS PROVIDE A FULL MEASURE OF THE ADVERSE CONSEQUENCES OF A PARTICUALR BORROWING BECAUSE INCREASED FEDERAL BORROWING CONTRIBUTES TO INFLATION.

Media Info

  • Monograph Title: ECONOMIC ANALYSIS IN HIGHWAY PROGRAMMING, LOCATION AND DESIGN: WORKSHOP CONFERENCE PROCEEDINGS, SEPTEMBER 17, 1959
  • Serial:

Subject/Index Terms

Filing Info

  • Accession Number: 00201828
  • Record Type: Publication
  • Files: TRIS, TRB
  • Created Date: Aug 26 1970 12:00AM