When calculating the NPV according to the method given above, all time intervals for the investment period are considered independently. The NPV method thus counts among the dynamic methods for accounting. Compared to static methods, this offers the advantage of modeling more complex circumstances, for example, different cash flows in the time intervals or a change in the discount interest rate.
The present net value enjoys great popularity, above all due to the relatively simple calculation method. The indicator is unambiguous and leaves no room for interpretation. However, critics question the net present value’s validity.
The net present value method is problematic mainly because of the following issues:
- The calculation of the net present value assumes a perfect capital market.
- In several respects, the calculation is based on subjective presuppositions which have a significant effect on the amount of the net present value.
The net capital value method assumes a highly simplified capital market – among other things, the equalization of debit and credit interest. Tax regulations are not considered either. In practice, these preconditions do not exist. As a consequence, it is an indicator that cannot be readily transferred to real circumstances.
In addition, there’s the risk that entrepreneurs will try to make those unprofitable investments based on false presuppositions look better. Both the discount interest and the cash flow amount are based on projections and are more or less determined arbitrarily if there is insufficient data. All presuppositions of the net present value calculation should therefore be commented on and sufficiently substantiated by (as examples) specific bank offers, industry data or business figures from previous years.
Click here for important legal disclaimers.