Discount rate
The annual rate used to convert future costs and revenues into present value, reflecting the time value of money and investment risk.
The discount rate translates future cash flows into today's money. A euro received in ten years is worth less than one today because capital could earn a return in the meantime and because future cash is uncertain.
At 8%, 100 EUR received in year 20 is worth 21 EUR today; at 4%, it is worth 46 EUR. This matters enormously for capital-intensive, long-lived assets like wind, solar, hydro and nuclear, where most costs are paid upfront and benefits accrue over 25 to 60 years.
For private investment appraisal, the discount rate is usually the WACC, expressed either nominal or real (net of inflation). Typical real WACC for renewables is 3 to 6% in Europe and North America and 8 to 12% or more in many emerging markets (IEA Cost of Capital Observatory). Moving from 3% to 10% roughly doubles the LCOE of solar PV and more than doubles that of nuclear, whose construction periods and lifetimes are longer.
Public policy analysis uses a social discount rate. The UK Green Book uses 3.5%, declining over long horizons; US OMB Circular A-4 (2023) lowered its default to 2%. The Stern Review on climate change (2006) used about 1.4%, while William Nordhaus favoured rates near 4 to 5%, a key reason their estimates of the social cost of carbon differ so widely. See also NPV.
Related terms
All terms →- WACC
Weighted average cost of capital: the blended return required by debt and equity investors, used as the discount rate for energy projects.
- NPV (Net Present Value)
The sum of all future cash flows of a project discounted to today, minus the initial investment; a positive NPV indicates value creation.
- LCOE (Levelized Cost of Electricity)
The constant price per MWh that recovers all lifetime costs of a power plant, discounted to present value, divided by its discounted lifetime output.
- IRR (Internal Rate of Return)
The discount rate at which a project’s net present value equals zero, representing its effective annual return.
- CAPEX
Capital expenditure: the upfront investment to build an energy asset, usually quoted per kW of capacity for power plants or per kWh for storage.
- Payback period
The time needed for the cumulative savings or revenues of an investment to equal its initial cost.