The selection of your discount rate to use in forestry projects depends on your time preference for spending money now versus later. It also depends on how you are using the discount rate you select. Is it before taxes or after taxes? Is it before inflation or after?
One of the basic challenges we are faced with in any business investment situation is the appropriate discount rate to use in determining the profitability of projects. Often, we derive this rate by looking for something comparable to other investments of similar risk and longevity. However, this comparison is complicated when some investments are adjusted for inflation while others are not. In other instances some investments may be listed before taxes have been levied, while others have not been. This makes direct comparisons very difficult, but not impossible.
Before we look at the idea of moving
between
tax rates and inflation we need to have a brief discussion of Effective
Annual Interest Rates and Nominal Annual Interest rates. It is standard
practice to specify interest rates in annual terms. However, when
interest
is compounded in continuous, daily, monthly, or quarterly terms, but
presented
in annual terms, a question arises as to the meaning of the annualized
rate. We need a mechanism to deal with this. When the annual rate is
calculated
by multiplying the periodic rate by the number of interest bearing
periods
per year, it becomes the nominal annual rate. The rate at which it is
actually
earned or paid is called the effective annual rate. Nominal interest is
the annual interest rate without considering the effect of any
compounding.
Effective interest is the annual interest rate, taking into account the
effect of compounding during the year.




Fortunately, the procedure of adjusting your discount rate to appropriately represent inflation and taxes has been made easier recently in a Southern Journal of Applied Forestry article by Steven H. Bullard and John E. Gunter. The article:
Adjusting Discount Rates for Income taxes and Inflation: A Three Step Process
SJAF 24(4) 2000 pp193195.
Southern Journal of Applied Forestry
Society of American Foresters
Download this article as a PDF file!
Using the procedures of these authors, you can easily adjust your discount rate appropriately and then use it in the investment formulae and in the decision criteria also found in this section of the MyForest.com web domain. The proper application of these principles requires that you combine the principles of discount rate with inflation (in the Economics Section) and taxes (in the Forest Taxation Section).
The authors point out in their article
that there are 3 basic steps to selecting the appropriate discount rate:
In the shaded diagram to the right, find the quadrant that represents the current discout rate you are using: 


Find the quadrant that represents the equivalent rate you would like to calculate 

Using a specific tax rate and/or inflation rate, apply the appropriate formulae. 
In order to make the transition from where you are now to where you want to be, we are here to help!
Read through the list below and select
the transition you want to complete. Click on the appropriate formulae
and you will be taken to the appropriate calculation page that includes
a few words about the transition.
Transition 



















Where:
i = the nominal (inflated) discount rate
r = the real (uninflated) discount rate
f = the annual rate of inflation
t = the marginal income tax rateb.t. indicates a before tax discount rate
a.t. indicates an aftertax discout rateand all rates are expressed in decimal percents
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