Reading the course notes about social discount rate was confusing to me. So I went back to the Rumble text to seek more clarity: “The social discount rate acts in must the same way as the opportunity cost in private enterprise. An opportunity cost is the value of that which must be given up to acquire or achieve something” (Rumble, 1997).
Approach for including the opportunity cost in deprecation per Rumble (1997):
- Determine the replacement value of the item
- Determine the useful life of the item
- Divide the replacement value of the item by the number of years of life to obtain the cost of depreciation for each year of use
- Multiply the undepreciated portion by the interest rate to obtain the opportunity cost of having resources invested in the undepreciated portion of the item
- Add the annual cost of the depreciation and the annual interest foregone on the remaining investment to obtain the annual cost
So I went back to the example from the course notes to double check how this works using Rumble’s approach. The course example is a computer that cost $2000 and is depreciated over 5 years. The simple depreciation is $2000/5 = $400.
- Determine the replacement value of the item: $2000
- Determine the useful life of the item: 5 years
- Divide the replacement value of the item by the number of years of life to obtain the cost of depreciation for each year of use: $2000/5 = $400
- Multiply the undepreciated portion by the interest rate to obtain the opportunity cost of having resources invested in the undepreciated portion of the item:
Year 1: ($1600 *.05) = $80 Year 2: ($1200 * .05) = $60 Year 3: ($800 * .05) = $40 Year 4: ($400 * .05) = $20 Year 5: ($0 * .05) = $0 - Add the annual cost of the depreciation and the annual interest foregone on the remaining investment to obtain the annual cost Year 1: ($1600 *.05) = $400 + $80 = $480 Year 2: ($1200 * .05) = $400 + $60 = $460 Year 3: ($800 * .05) = $400 + $40 = $440 Year 4: ($400 * .05) = $4000 + $20 = $420 Year 5: ($0 * .05) = $400 + $0 = $400
Going back to the Rumble definition, the total social discount rate or the amount that is given up by the organization in order to own the computer is $2200. This does not jibe with the course notes which has the total at $2,415.
REFERENCES
Rumble, G. (1997). The costs and economics of open and distance learning [Adobe Digital Editions Version]. Retrieved from Amazon.com