Another important consideration in the quantitative analysis of procurement options is the choice of discount rate. The discount rate reflects the time value of money as well as any risk premium associated with a project, and is determined based on the risk profile of a project and prevailing market conditions. Discounting enables nominal project cash flows6 that differ in terms of timing and amount to be discounted back to a common reference date, usually to their present value. Discounting in this way allows procurement methods with different cash flow impacts to be compared on a like-for-like basis. Comparing competing options in this way provides an objective means of determining the approach that provides the best value in terms of cost.
The key quantitative elements introduced above are discussed in detail in the following sections.
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6 Nominal cash flows reflect the anticipated impact of inflation and/or construction escalation on the periodic costs of the project.