Editing Net present value (section)

==Advantages and disadvantages of using Net Present Value==
NPV is an indicator for project investments, and has several advantages and disadvantages for decision-making.

===Advantages===
The NPV includes all relevant time and cash flows for the project by considering the [[time value of money]], which is consistent with the goal of wealth maximization by creating the highest wealth for shareholders.

The NPV formula accounts for [[cash flow]] timing patterns and size differences for each project, and provides an easy, unambiguous dollar value comparison of different investment options.<ref name=":0">{{Cite book |last=Serfas |first=Sebastian |title=Cognitive Biases in the Capital Investment Context |publisher=Cabler Verlag |year=2011 |isbn=9783834926432 |location=Germany |pages=30–255 |language=en-au}}</ref><ref name=":1">{{Cite web |title=Net Present Value (NPV): What It Means and Steps to Calculate It |url=https://www.investopedia.com/terms/n/npv.asp |access-date=2023-04-21 |website=Investopedia |language=en}}</ref>

The NPV can be easily calculated using modern spreadsheets, under the assumption that the discount rate and future cash flows are known. For a firm considering investing in multiple projects, the NPV has the benefit of being additive. That is, the NPVs of different projects may be aggregated to calculate the highest wealth creation, based on the available capital that can be invested by a firm.<ref>{{Cite web |title=Some Alternative Investment Rules |url=https://webpage.pace.edu/pviswanath/notes/corpfin/invrules.html |access-date=2023-04-21 |website=webpage.pace.edu}}</ref>

===Disadvantages===

The NPV method has several disadvantages.

The NPV approach does not consider hidden costs and project size. Thus, investment decisions on projects with substantial hidden costs may not be accurate.<ref>{{Cite book |last1=Ngwira |last2=Manase |first1=Malawi |first2=David |title=Public Sector Property Asset Management |publisher=Wiley-Blackwell |year=2016 |isbn=978-1-118-34658-7 |location=UK |pages=115–193 |language=en-uk}}</ref>

====Relies on input parameters such as knowledge of future cash flows====
The NPV is heavily dependent on knowledge of future cash flows, their timing, the length of a project, the initial investment required, and the discount rate. Hence, it can only be accurate if these input parameters are correct; although, sensitivity analyzes can be undertaken to examine how the NPV changes as the input variables are changed, thus reducing the uncertainty of the NPV.<ref>{{Cite web |title=Sensitivity Analysis Definition |url=https://www.investopedia.com/terms/s/sensitivityanalysis.asp |access-date=2023-04-21 |website=Investopedia |language=en}}</ref>

====Relies on choice of discount rate and discount factor====
The accuracy of the NPV method relies heavily on the choice of a discount rate and hence [[Discounting|discount factor]], representing an i[[Risk premium|nvestment's true risk premium]].<ref>{{Cite web |title=Disadvantages of Net Present Value (NPV) for Investments |url=https://www.investopedia.com/ask/answers/06/npvdisadvantages.asp |access-date=2022-04-30 |website=Investopedia |language=en}}</ref> The discount rate is assumed to be constant over the life of an investment; however, discount rates can change over time. For example, discount rates can change as the cost of capital changes.<ref>{{Cite web |last=Damodaran |first=Aswath |date=21 April 2023 |title=Cash Flow and Discount Rates |url=https://pages.stern.nyu.edu/~adamodar/podcasts/valUGspr21/session4slides.pdf |access-date=21 April 2023 |website=New York University}}</ref><ref name=":0" /> There are other drawbacks to the NPV method, such as the fact that it displays a lack of consideration for a project’s size and the [[cost of capital]].<ref>{{Cite journal |last1=Fioriti |first1=Davide |last2=Pintus |first2=Salvatore |last3=Lutzemberger |first3=Giovanni |last4=Poli |first4=D. |date=2020-06-01 |title=Economic multi-objective approach to design off-grid microgrids: A support for business decision making (comparison of different economic criteria) |url=https://www.researchgate.net/publication/342147652 |journal=Renewable Energy |doi=10.1016/j.renene.2020.05.154|s2cid=224855745 }}</ref><ref name=":1" />

====Lack of consideration of non-financial metrics====
The NPV calculation is purely financial and thus does not consider non-financial metrics that may be relevant to an investment decision.<ref>{{Cite web |last=Mendell |first=Brooks |date=2020-05-31 |title=Pros and Cons of Using Net Present Value (NPV) |url=https://forisk.com/blog/2020/05/31/pros-and-cons-of-using-net-present-value-npv/ |access-date=2023-04-21 |website=Forisk |language=en}}</ref>

====Difficulty in comparing mutually exclusive projects====
Comparing mutually exclusive projects with different investment horizons can be difficult. Since unequal projects are all assumed to have duplicate investment horizons, the NPV approach can be used to compare the optimal duration NPV.<ref>{{Cite book |last=de Rus |first=Ginés |title=Introduction to Cost-Benefit Analysis: Looking for Reasonable Shortcuts. Second edition, 2021 |publisher=Edward Elgar |year=2021 |isbn=978-1-83910-374-2 |location=UK |pages=136–245 |language=en-us}}</ref>