Editing Net present value (section)

== Common pitfalls ==
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* If, for example, the ''R''<sub>''t''</sub> are generally negative late in the project (''e.g.'', an industrial or mining project might have clean-up and restoration costs), then at that stage the company owes money, so a high discount rate is not cautious but too optimistic. Some people see this as a problem with NPV. A way to avoid this problem is to include explicit provision for financing any losses after the initial investment, that is, explicitly calculate the cost of financing such losses.
* Another common pitfall is to adjust for risk by adding a premium to the discount rate. Whilst a bank might charge a higher rate of interest for a risky project, that does not mean that this is a valid approach to adjusting a net present value for risk, although it can be a reasonable approximation in some specific cases. One reason such an approach may not work well can be seen from the following: if some risk is incurred resulting in some losses, then a discount rate in the NPV will reduce the effect of such losses below their true financial cost. A rigorous approach to risk requires identifying and valuing risks explicitly, ''e.g.'', by actuarial or [[Monte Carlo method|Monte Carlo]] techniques, and explicitly calculating the cost of financing any losses incurred.
* Yet another issue can result from the compounding of the risk premium. R is a composite of the risk free rate and the risk premium. As a result, future cash flows are discounted by both the [[risk-free rate]] as well as the risk premium and this effect is compounded by each subsequent cash flow. This compounding results in a much lower NPV than might be otherwise calculated. The [[certainty equivalent]] model can be used to account for the risk premium without compounding its effect on present value.
* Another issue with relying on NPV is that it does not provide an overall picture of the gain or loss of executing a certain project. To see a percentage gain relative to the investments for the project, usually, [[Internal rate of return]] or other efficiency measures are used as a complement to NPV.
* Non-specialist users frequently make the error of computing NPV based on cash flows after interest. This is wrong because it double counts the time value of money. Free cash flow should be used as the basis for NPV computations.
* When using Microsoft's Excel, the "=NPV(...)" formula makes two assumptions that result in an incorrect solution.  The first is that the amount of time between each item in the input array is constant and equidistant (e.g., 30 days of time between item 1 and item 2) which may not always be correct based on the cash flow that is being discounted.  The second item is that the function will assume the item in the first position of the array is period 1 not period zero.  This then results in incorrectly discounting all array items by one extra period.  The easiest fix to both of these errors is to use the "=XNPV(...)" formula.