Nesje, F., Drupp, M. A., Freeman, M. C. and Groom, B. (2023) Social Science Research Network, Working Paper
Abstract: We critically assess an almost universal Net Present Value (NPV) practice. In addition to the central NPV, analysts frequently also report multiple additional values in what is commonly referred to as NPV ‘sensitivity analysis’. This practice is often justified with reference to the future net benefits to the asset being uncertain, because the correct discounting model is difficult to identify, or for other reasons. The purpose of this paper is to explain clearly why, despite the fact that this is recommended as best practice across multiple prestigious and influential sources, the reporting of more than one NPV value either lacks sufficient theoretical support or reflects decisions taken at an inappropriate organizational level. By providing additional quantification rather than recognizing that investment decisions require qualitative managerial judgement, this practice may confuse decision-makers more than help them. We illustrate this point in relation to a number of current guidelines across the public and private sectors and with particular focus on the US Environmental Protection Agency’s latest estimates of the Social Cost of Carbon.
