Budgeting Basics and Beyond

20.13. Capital Budgeting and Nonprofit Organizations

With regard to nonprofit institutions, the only real problem in using capital budgeting is the selection of an appropriate discount rate. Some nonprofit entities employ the interest rate on special bond issues (e.g., building a school) as the discount rate. Others employ the interest rate that could be earned by putting money in an endowment fund instead of spending it on capital improvements. Discount rates arbitrarily established by governing boards also are used. Chapter 24 takes up this subject in detail.

Caution: Guard against using an excessively low discount rate. This may result in accepting projects that will not be profitable. To guard against this problem, the Office of Management and Budget promulgates a discount rate of at least 10 percent on all projects to be considered by federal government units (Office of Management and Budget Circular No. A-94, March 1972).

Recommendation: In the case of nonprofit units such as schools and hospitals, the discount rate should be the average rate of return on private sector investments. The average discount rate will provide more meaningful results than using a specific interest rate on a special bond issue or the interest return on an endowment fund.