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Title:Selection of Interest and Inflation Rates for Infrastructure Investment Analyses
Authors:Xiao Qin, Kai Wang, and Zhiguang Wang
Publication Date:Dec 2014
Report #:MPC-14-275
Project #:MPC-398
TRID #:01554394
Keywords:cost indexes, decision making, economic analysis, inflation, infrastructure, interest rates, investments, life cycle costing, methodology

 

Abstract

Engineering economic analyses (EEA) apply economic methodologies to engineering problems for decision-making support. When conducting an EEA, interest and inflation rates are the two critical factors. Using inappropriate values for interest and inflation rates could affect decision-making, such as unfairly favoring specific industries (e.g. concrete over asphalt or vice versa), over- or under-budgeting future projects. It is necessary to identify the appropriate methodology to measure interest and inflation rates to enhance the credibility and reliability of investment decisions.

The current assumption of a zero interest rate in the SDDOT EEAs may be problematic. Zero interest rate is unable to differentiate projects with various life cycles but in reality interest rates vary by time. Additionally, the use of a general inflation rate may be debatable because the price of materials and labor can vary by type and area.

In this research, SDDOT's current uses of interest and inflation rates were identified through interviews. The new approach to establishing interest and inflation rates was developed from the combination of basic economic principles and state-of-the-art methodologies. Specifically, a non-zero interest rate was calculated by the treasury and state-issued bond yields; the region- and material-specific inflation rates were measured, calculated, and applied to the SDDOT LCCA studies; and the composition of SDCCI was re-examined and modified. In conclusion, this study introduced improved methodologies to calculate the discount rate for an EEA, presented the advantages of using a more specific inflation rate over a general inflation rate, and illustrated the consequence of selecting inappropriate rates.

How to Cite

Qin, Xiao, Kai Wang, and Zhiguang Wang. Selection of Interest and Inflation Rates for Infrastructure Investment Analyses, MPC-14-275. North Dakota State University - Upper Great Plains Transportation Institute, Fargo: Mountain-Plains Consortium, 2014.

NDSU Dept 2880P.O. Box 6050Fargo, ND 58108-6050
(701)231-7767ndsu.ugpti@ndsu.edu