Limitations of Net Present Value
The net present value (NPV) method is a theoretically sound method. In practice, it may pose some computation problems.
- Cash flow estimation. The net present value (NPV) method is easy to use if fore casted cash flows are known. In practice, it is quite difficult to obtain the estimates of cash flows due to uncertainty.
- Discount rate. It is also difficult in practice to precisely measure the discount rate.
- Mutually exclusive projects. Further, caution needs to be applied in using the net present value (NPV) method when alternative projects with unequal lives, or under funds constraint are evaluated. The net present value (NPV) rule may not give unambiguous results in these situations.
• Ranking of projects. It should be noted that the ranking of investment projects as per the net present value (NPV) rule is not independent of the discount rates.
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