Sense and sensitivity: An argument against reporting multiple Net Present Values

27 Pages Posted: 20 Dec 2023

See all articles by Frikk Nesje

Frikk Nesje

University of Copenhagen - Department of Economics

Moritz A. Drupp

University of Hamburg - Faculty of Business, Economics, and Social Sciences

Mark C. Freeman

University of York

Ben Groom

University of Exeter

Date Written: December 13, 2023

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.

Keywords: Net Present Value, Sensitivity Analysis, Benefit-Cost Analysis, Social Discounting

JEL Classification: D61, D81, G31, Q51, Q54

Suggested Citation

Nesje, Frikk and Drupp, Moritz A. and Freeman, Mark and Groom, Ben, Sense and sensitivity: An argument against reporting multiple Net Present Values (December 13, 2023). Available at SSRN: https://ssrn.com/abstract=4663124 or http://dx.doi.org/10.2139/ssrn.4663124

Frikk Nesje

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5, Bygn 26
Copenhagen, 1353
Denmark

Moritz A. Drupp

University of Hamburg - Faculty of Business, Economics, and Social Sciences ( email )

Von-Melle-Park 9
Hamburg, 20146
Germany

Mark Freeman (Contact Author)

University of York ( email )

Heslington
University of York
York, YO10 5DD
United Kingdom

Ben Groom

University of Exeter ( email )

Northcote House
The Queen's Drive
Exeter, Devon EX4 4QJ
United Kingdom

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