The Determination Of Equivalent Value In Life-cost Studies: An Intergenerational Approach

Abstract

Past analyses of design solutions for building projects have concentrated on initial capital costs, often to the extent where the effects of subsequent operating costs are completely ignored. However, even in cases where a wider view of cost has been adopted, the discounting process has commonly disadvantaged future expenditure so heavily as to make performance after the short term irrelevant to the outcome, resulting in projects which display low capital and high operating costs to be given favour. Thus design solutions that aim to avoid repetitive maintenance, reduce waste, save nonrenewable energy resources or protect the environment through selection of better quality materials and systems, usually having a higher capital cost, are often rejected on the basis of the discounting process. Furthermore, the formulation of the discount rate has normally lacked rigour and has often resulted in an assumed rate that has implied profit and risk and has ignored taxation.

Discounted present value is a measure of equivalence for time-phased costs and benefits derived from consideration of the theoretical investment return, preferably after tax. As it takes account of the cost of money, discounting can be described as leading to the determination of equivalent value using an investment-based or capital productivity approach. It is hypothesized and verified that the value of future costs and benefits is additionally susceptible to fluctuations in their base worth over time as reflected by changes in incremental escalation and the affordability of goods and services between present and future generations. Making adjustments for changes in worth may thus be described as contributing to the determination of equivalent value using a prosperity-based or time preference approach.

The analysis of Australian sectorial income and expenditure data over a forty-year period shows that affordability changes can be measured and represented as an index. The discount rate is identified as a combination of the real weighted cost of capital, differential price level changes and diminishing marginal utility, where the latter is depicted by changes in the affordability of goods and services. This results in a composite discount rate that encompasses project-related, product-related and investor-related attributes. Tangible (financial) costs and benefits are discounted by this rate while intangible (environmental and social) costs and benefits are left as real value. Recommendations concerning the determination of equivalent value should ensure that the future operating performance of projects is more equitably assessed and that sustainable development remains an achievable objective in life-cost studies.