Changes

The table shows present value factors at different interest rates (or ''discount rates'') in future years. Some corporations use a discount rate approximately equal to the corporate cost of capital, or the present inflation rate, plus an additional 3-4% (which represents "real" bank interest). At the time this paper was written, this gave an 8-9% [[corporate discount rate]]. During this time, however, most U.S. companies were using a discount rate of 12-15%, and international firms were using 15-18%.

The table shows present value factors at different interest rates (or ''discount rates'') in future years. Some corporations use a discount rate approximately equal to the corporate cost of capital, or the present inflation rate, plus an additional 3-4% (which represents "real" bank interest). At the time this paper was written, this gave an 8-9% [[corporate discount rate]]. During this time, however, most U.S. companies were using a discount rate of 12-15%, and international firms were using 15-18%.

Some corporations advocate calculating an average [[reinvestment opportunity rate]] based on past performance and using this discount rate. When the historical record is analyzed (sometimes called a ''post audit''), the analysis can be done on both a dollars-of-the-day basis and in terms of constant purchasing power dollars. It is not an easy task to put all the project cash flows in terms of constant purchasing power for the "basket of goods" the corporation purchases. The concept of using the future price or cost increases of the capital goods purchased by the corporation as an index for loss of purchasing power is discussed in a paper by Krasts and Henkel<ref>Krasts, A., and T. Henkel, 1977, Effect of inflation on discounted cash flow rates of return: Managerial Planning, Nov/Dec, p. 21-26</ref>, in which they apply the concept to discounted cash flow rate of return (DCFROR) calculations. When the post audit avera

Some corporations advocate calculating an average [[reinvestment opportunity rate]] based on past performance and using this discount rate. When the historical record is analyzed (sometimes called a ''post audit''), the analysis can be done on both a dollars-of-the-day basis and in terms of constant purchasing power dollars. It is not an easy task to put all the project cash flows in terms of constant purchasing power for the "basket of goods" the corporation purchases. The concept of using the future price or cost increases of the capital goods purchased by the corporation as an index for loss of purchasing power is discussed in a paper by Krasts and Henkel<ref>Krasts, A., and T. Henkel, 1977, Effect of inflation on discounted cash flow rates of return: Managerial Planning, Nov/Dec, p. 21-26</ref>, in which they apply the concept to discounted cash flow rate of return (DCFROR) calculations. When the post audit average constant purchasing power rate of return is used as the discount rate in net present value calculations, the effect is that projects are compared assuming treasury growth. The project cash flows must also be in terms of constant purchasing power.

e constant purchasing power rate of return is used as the discount rate in net present value calculations, the effect is that projects are compared assuming treasury growth. The project cash flows must also be in terms of constant purchasing power.

This brief discussion demonstrates the diverse approaches that are used to estimate the proper discount rate. This topic deserves more research. For example, should multiple discount rates be used--one discount rate for high risk exploration projects versus a lower discount rate for lower risk development projects? At issue here is how to best deal with risk. A good case can be made for using expected values (probabilistic approach) to account for risk and using the discount rate to account for the time value of money (Thompson and Wright, 1992<ref>Thompson, R. S., and J. D. Wright, 1992, Oil and gas property evaluation, 3rd ed.: Golden, CO, Thompson-Wright Associates.</ref>). ''This method is strongly recommended by the author.''

This brief discussion demonstrates the diverse approaches that are used to estimate the proper discount rate. This topic deserves more research. For example, should multiple discount rates be used--one discount rate for high risk exploration projects versus a lower discount rate for lower risk development projects? At issue here is how to best deal with risk. A good case can be made for using expected values (probabilistic approach) to account for risk and using the discount rate to account for the time value of money.<ref>Thompson, R. S., and J. D. Wright, 1992, Oil and gas property evaluation, 3rd ed.: Golden, CO, Thompson-Wright Associates.</ref>) ''This method is strongly recommended by the author.''

The "Rule of 72" is a useful rule of thumb that allows us to estimate the doubling time or rate of any proposed investment. To find the doubling time of a sum invested at any compounded interest rate, divide the interest rate into 72. For example, at 12% compounded annual interest, the investment will approximately double in six years.

The "Rule of 72" is a useful rule of thumb that allows us to estimate the doubling time or rate of any proposed investment. To find the doubling time of a sum invested at any compounded interest rate, divide the interest rate into 72. For example, at 12% compounded annual interest, the investment will approximately double in six years.

More detailed discussions of the time value of money can be found in Thompson and Wright (1985)<ref>Thompson, R. S., and J. D. Wright, 1985, Oil property evaluation, 2nd ed.: Golden, CO, Thompson-Wright Associates, 212 p.</ref>.

More detailed discussions of the time value of money can be found in Thompson and Wright<ref>Thompson, R. S., and J. D. Wright, 1985, Oil property evaluation, 2nd ed.: Golden, CO, Thompson-Wright Associates, 212 p.</ref>.

==References==

==References==