Impact of the Discount Rate on Long Life Pavement Capital Improvements: A Discussion of the Financial Inputs

One of the most influential characteristics of a life cycle cost analysis (LCCA) is the discount rate. This paper looks at the impact of using a real discount rate that does not take into account the individual inflation rates for each commodity, the decline of the purchasing power of the agency’s dollar value, and the rate of transportation dollars being deposited for programming. A premise in using the real discount rate is the use of constant or real dollars when looking at future activities. Constant dollars essentially equate the future purchasing power of the dollar to be the same as today’s purchasing power. The paper will demonstrate that this is not the case which is further substantiated by the adjustment in contract price that many State transportations agencies allow for this purpose. Most agencies assume a 30-year Treasury rate as the basis when computing their real discount rate for use in pavement type selection. An improved approach would be to look at the agency’s projected funding levels on an annual basis as the rate of return for their investment and using individual commodity rates of inflation to account for future expenditures. This would account for anticipated deposits that can be programmed for future work.