In fact, project B now has a present value greater than project A because returns in the future make greater contributions to present value when the discount fact is lower. Choice of the appropriate discount rate clearly matters for public decisions – an artificially high or low rate can lead to wasteful choices.
Analysts sometimes compare alternatives by determining what discount rate would cause the present value of projects under considerations to be equal. Thus, the present value of projects A and B would be the same, at a rate around 4 percent. If the rate is above that level, A is better; if below, B is better.
In many situations, the income stream to be discounted may be constant for several years. For instance, a new maintenance garage might reduce costs by $20,000 per year for twenty-five years, and that cost saving is to be compared with the construction cost of the garage. The flow in each year could be discounted back to the present; a quicker approach entails use of an annuity formula to compute the present value of the income stream in a single computation. If S equals the amount of the annual flow and other variables are as previously defined,