Question

Imagine that the foundation on your house is cracking. If you repair it now before it gets worse it will only cost you $1000. If you put it off you expect that it will last 30 more years before you have to fix it. At that point, it will cost $3000 to fix it. Which of these choices will save you money in the long run if the discount rate is 3%? 6%? Show your work.

What other factors might influence this decision?

Based on the preceeding example, would a high or low discount rate favor immediate (and costly) action to mitigate climate change rather than waiting for future (even more costly action)?Explain your reasoning.

Answer 1

Using table enclosed, Present Value (PV) of $ 1 for 30 years @:

• 3% is 0.4120
  meaning $ 3000 pv is: 3000 x .4120 = $ 1236
  
• 6% is 0.1741
  meaning $ 3000 pv is: 3000 x .1741 = 522.3

Option 1 (3% interest rate) implies that if we spend $ 1236 today or $3000 after 30 years from now, there's no difference in value of money.. meaning spending anything less than $ 1236 today will make sense as it would mean spending lesser than $ 3000 after 30 years.. This implies that spending $ 1000 today on repairs is more logical rather than waiting for 30 years to spend $ 3000.. because $ 3000 will be a higher expense than today after the said time period @ 3%

Option 2 (6% interest rate) implies that if we spend $ 522.3 today or $3000 after 30 years from now, there's no difference in value of money.. meaning spending anything more than $ 522.3 today will not make sense as it would mean spending more than $ 3000 after 30 years.. This implies that spending $ 1000 today on repairs is not logical and we should wait for 30 years and spend $ 3000 then.. because $ 3000 will be a lower expense than today after the said time period @ 6%

Other factors: Weather condition, preference of house owner if he's indifferent between present and future value of money, interim sale of asset yielding higher return than cost of repairs etc