The economic opportunity cost of capital in South Africa

Abstract

AN INVESTMENT PROJECT USUALLY LASTS FOR MANY YEARS. To determine if the project should be implemented, the net present value of the project is considered the most satisfactory criterion for use in its economic appraisal.1 This criterion requires the use of a discount rate in order to be able to compare the benefits and costs that arise in different time periods over the life of the investment. The economic opportunity cost of capital (EOCK) is the appropriate discount rate to use when estimating the economic net present value of a project. This hurdle rate applies not only to investments financed solely with public funds but also to investments in the form of joint public-private ventures and the provision of fiscal incentives to private investment. If the economic net present value of the project is greater than zero, the project is potentially worth implementing. This implies that the project would generate more net economic benefits than if the resources had been used elsewhere in the economy. On the other hand, if the net present value is less than zero, the project should be rejected on the ground that the resources invested could be put to better use if they were left to be allocated by the capital market. This paper describes an analytical framework that will enable us to estimate the economic cost of capital in South Africa.