Social Valuation of Projects - Harberger's Social Discount Rate and the Pricing of Risky Projects #246021

The purpose of the current paper is to derive a simple valuation rule that takes into account both the tax distortions and project-risk considerations. The analysis will show that Bailey and Jensen's solution is wrong. The main result is that the tax distortions might lead to define a hurdle rate for certainty equivalent projects which differs from the market rate of interest, but that in general the project risk adjustments are independent of the tax distortions. This solution is similar to the one proposed by Schmalensee[1976]. The main difference is that the current paper proposes a very simple derivation of the result which relies on both a version of Fischer Black[1981] Simple Discounting Rule to characterize the tax externalities, and an Adjusted Present Value Rule to account for these in public project valuations.