Making Investment Decisions with NPV

The previous chapters have set out the basic model of a business case using the net present value (NPV) technique. While the model is simple and straightforward, it can very well manage to cope with all kinds of complexity that real-life investment decisions throw at the business case team. Yet NPV and the need for formal investment decision methods are frequently discussed in organizations. Approving new investments often means a change in the way an organization does business and runs its processes; change of any sort is always a challenge in an organization. But most managers who argue against formal investment decision methods are only criticizing the way in which these methods are applied, and rarely the underlying processes or methods themselves. In order to overcome such concerns, this chapter takes the introduction to NPV as provided in Section 2.2 a step further and highlights a few areas which require attention and consideration in practical business cases: What if cash flows do not occur once a year, but come in and leave the company continuously? (Section 5.1) What method to use for estimating the terminal value of an investment at the end of the investment’s lifespan? (Section 5.2) How to compare investments with different time horizons, i.e. which do not necessarily start and end at the same time or where the start time is an option? (Section 5.3) How to deal with resource constraints? (Section 5.4) If there is a risk of inflation, how does the NPV calculation need to be adjusted? (Section 5.5)