Impact in year 5 yr4 impact less drop-off
£1,121.93 less 10%
£1,121.93 x 0.9 = £1,009.74
5.2 Calculating the net present value
In order to calculate the net present value (NPV) the costs and benefits paid or received
in different time periods need to be added up. In order that these costs and benefits
are comparable a process called discounting is used. Discounting recognises that
people generally prefer to receive money today rather than tomorrow because there is
a risk (eg, that the money will not be paid) or because there is an opportunity cost (eg,
potential gains from investing the money elsewhere). This is known as the ‘time value
of money’. An individual may have a high discount rate – for example, if you would
accept £2 in one year’s time, instead of £1 now, that implies a discount rate of 100%.
This is a controversial area and one where there is ongoing research and discussion.
The main problem with using discounting in SROI is that it encourages short-termism
by discounting the future. This is especially problematic for environmental outcomes,
where the value may even increase. This betrays the extent to which people actually
value their future and their children’s future.
There is a range of different rates. For the public sector, the basic rate recommended
in HM Treasury’s Green Book is 3.5%. The Stern Review on the economics of climate
change argued that it was not ethically defensible for pure time preference to be
applied to cost-benefit calculations where these involved significant wealth transfers
from the future to the present and used lower rates. Following the Stern Review, HM
Treasury published supplementary guidance on intergenerational wealth transfers,
in which a reduced discount rate of 3%, which eliminates the pure time preference
element, is applied alongside the usual discount rate.
2
Stag
This issue is under review by the Measuring Social Value consortium, and the aim is to
Stag
e
produce further guidance on discounting in due course.
e
The process is to discount the projected values over time, as you set out in stage
5.1, above. This can be easily done if you are using Excel, which has functions for
calculating Present Value and Net Present Value.
Although this calculation is automated in Excel (=NPV, discount rate, value1, value 2…),
it may be useful to know how the calculation for Present Value works and this is shown
below (‘r’ represents the discount rate):
2 More information on the different elements that make up the discount rate is set out in Annex 6 of the Green Book.
A guide to Social Return on Investment
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