Models of time and value representation, interest conventions and inflation in project evaluation

"Any study in the field of theoretical investment analysis, or practical project evaluation, must be based on the assumption of one of the commonly applied models of time and value representation, and the corresponding interest convention. The lack of clear assumptions in this regard may easily confuse both the author of the study and the reader, and sometimes even lead to inaccurate results.In the first part of this paper formal definitions of the continuous and discrete models of time and value representation are introduced; in the second part, the importance of transparent assumptions is shown using a concrete example of inflation calculation in project evaluation.IntroductionIn his recent paper, L.D. Smith(10) discusses an important aspect of mine investment analysis: inflation in project evaluation. His interesting presentation of current practices of handling inflation by Canadian and international mining companies in their feasibility studies ends, in the conclusions, with a call for clear assumptions made when evaluating mining projects.With this call, an important issue has been addressed. The lack of clearly stated assumptions, or their incompleteness, are relatively frequent with regard to the interest convention or the model of time and value representation assumed when evaluating mining projects. It is, for example, fairly common that the quantitative evaluation of a project is performed according to the discrete model of time and value representation and the discrete interest convention, and the graphical presentation, supporting this evaluation, reflects the continuous model.Sometimes such an ambivalency means nothing more than just a formal inconsistency; there are cases , however, that may well lead to a serious confusion and /or to inaccurate results . Before this can be demonstrated on a specific example, a concise description of the models of time and value representation used in the evaluation of industrial projects seems to be in order. Although these models (especially the discrete one) have been in common use in the research and practice of financial analysis for considerable period of time, they have been applied rather intuitively, and their forma] definitions are difficult to find even in the standard textbooks on Engineering Economy."