C15: Discount rates and expected rates of return

Discount rates are used on the Option Appraisal form. They are used to determine the Net Present Value of a project (NPV). The only issue is that no clear guidance exists on what is an appropriate discount rate.

Discount rates are used to assess three factors:

• The value society attaches to present, as opposed to future consumption.
• The time value of money, for example if offered £100 today or £100 in one year’s time it is rational to accept the £100 now as you could invest the money in a low risk asset (eg building society account) and have more than £100 in one years time.
• Risk: in the option above if offered £100 now in repayment of a debt of that value, or £200 in a year’s time, then, assuming the individual offering the money was very trustworthy you may be inclined to accept the £200. Alternatively if the individual was not trustworthy then you may be inclined to take the £100 now. Whilst this is a very simplistic example it indicates that when assessing the value of money over time we also assess the risks arising from the income source. Discount rates endeavour to do this.

For projects between 0 and 30 years the risk free discount rate will be the Bank of England base rate; the actual rate(s) used by the University do need to be higher than this and the discount rate used to evaluate projects will be the risk free discount rate + the RPIX.

For the purposes of the University capital procedures Council has agreed that three main discount rates should apply to the University (the current rates are shown on the Option Appraisal form‌):

Core activities

Core activities are those related to mainstream teaching and research activities. It is also to be used for infrastructure developments largely focussed developing the mainstream teaching and research activities.

Non-Core related activities

These are activities linked to or supporting the mainstream and teaching activities but are not vital to be undertaken by the University and / or carry different risk characteristics. Included in here are projects related to student residences and international students.

Other rates

For projects where the driver is to generate a surplus or where the risks are significantly higher the Project Manager in association with the ICG will need to agree a suitable discount rate. In these circumstances the investment appraisal narrative should explain the choice of the rate and explain its suitability.

The current applicable rates are shown on the Optional Appraisal Form within the Project Authorisation Workbook.