Allowing for differential timing in cost analyses: discounting and annualization

TLDR

Cost timing differences arise because inputs are incurred and used at different times over a programme’s lifetime, and discounting addresses time preference by reducing the value of future costs to reflect current resource preferences. The study aims to compare cost data over time by presenting methods for discounting and annualizing costs and offering rules‑of‑thumb for when to apply these adjustments. The authors describe procedures for discounting future costs and for annualizing recurrent costs to obtain equivalent annual costs. The approach demonstrates how capital items are utilized over an intervention’s lifetime.

Abstract

There are differences in timing related to when costs of certain inputs are incurred and when they are used over the lifetime of a programme. This paper looks at the issues related to the comparison of cost data over time focusing on discounting and annualization adjustments, which are used by economists to calculate financial and economic costs. The process of discounting is used to deal with the notion of time preference. Time preference implies that future costs are worth less, and hence discounted more, to reflect individual and societal preferences to have resources and money now rather than in the future. While discounting is appropriate in many situations, it is also useful to compute an annual equivalent cost when recurrent costs of an intervention are incurred, or are expected to be incurred, in subsequent years. This approach has the added benefit of illustrating how capital items are actually used during the lifetime of an intervention. This paper presents methods to both discount and annualize costs, and discusses rules-of-thumb to decide when to make these adjustments.