From the Shadow Price of Capital to the Marginal Cost of Funds: In Search of the Implementation of a Principle

The "folk principle" for multi-period project evaluation states that if all the costs and benefits of a project are expressed as withdrawals from and increments to private consumption at different time points, then the appropriate discount rate is the consumer's rate of interest. The shadow price of capital (SPC) approach intends to implement this principle, but faces serious practical difficulties. By taking a utility-based perspective, this paper explains why the SPC approach cannot fully implement the folk principle even theoretically. Then, it derives, as a complete implementation of the folk principle, a multi-period cost-benefit rule that is based on the concept of the marginal cost of funds.