Some Damages Experts Incorrectly Compute Real Discount Rates
In calculating economic losses that occur after some date, for instance, lost wages after the date of trial, it is necessary to compute the present value of all such future values. In some courts, a below-market interest rate is used to compute said present values. A below-market discount rate is generally derived as the nominal interest yield on an investment instrument adjusted for anticipated inflation. (A nominal interest rate refers to the rate of interest prior to taking inflation into account. A real interest rate refers to the rate of interest after removing the effects of inflation.)
On too frequent a basis, I have encountered economic loss experts who incorrectly calculate the real rate by subtracting the inflation component from the nominal interest rate. In other words, they compute R.R. = N.R. – I.R., where R.R. represents the real rate, N.R. signifies the nominal rate, and I.R. identifies the inflation rate. The correct formula is R.R. = (1 + N.R.) / (1 + I.R.) – 1.
Conceivably, those who utilize the incorrect formula might argue that only in instances where N.R. and I.R. differ by a sufficiently wide margin will the impact on “the bottom” line be significant. But that misses the point: in mathematics something is correct or it is not. Using a demonstrably incorrect formula can only result in an economic loss figure that is inaccurate, and therefore, unreliable.
(If you would like to review a source more authoritative than the author that identifies the correct formula, contact Dr. Boisso at (214) 394-3165 or Dale@BoissoAndAssociates.com.)