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Sense and Sensitivity: An Argument Against Reporting Multiple Net Present Values

Author

Listed:
  • Frikk Nesje
  • Moritz A. Drupp
  • Mark C. Freeman
  • Ben Groom

Abstract

We critically assess an almost universal Benefit-Cost Analysis (BCA) practice. In addition to the central Net Present Value (NPV), analysts frequently also report multiple additional values in what is commonly referred to as ‘NPV sensitivity analysis’. This practice is generally justified with reference to the future net benefits to the asset being risky, or because the correct discounting model is difficult to identify. We explain why, despite the fact that this is recommended as best practice across multiple prestigious and influential sources, the reporting of more than one NPV either lacks sufficient theoretical support or reflects decisions taken at an inappropriate level within the organizational hierarchy. As a consequence, 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.

Suggested Citation

  • Frikk Nesje & Moritz A. Drupp & Mark C. Freeman & Ben Groom, 2024. "Sense and Sensitivity: An Argument Against Reporting Multiple Net Present Values," CESifo Working Paper Series 11547, CESifo.
    • Handle: RePEc:ces:ceswps:_11547
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    File URL: https://www.cesifo.org/DocDL/cesifo1_wp11547.pdf
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    References listed on IDEAS

    as
    1. Richard G. Newell & William A. Pizer & Brian C. Prest, 2022. "A Discounting Rule for the Social Cost of Carbon," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 9(5), pages 1017-1046.
    2. Ulrich K. Muller & James H. Stock & Mark W. Watson, 2022. "An Econometric Model of International Growth Dynamics for Long-Horizon Forecasting," The Review of Economics and Statistics, MIT Press, vol. 104(5), pages 857-876, December.
    3. Magni, Carlo Alberto & Marchioni, Andrea, 2020. "Average rates of return, working capital, and NPV-consistency in project appraisal: A sensitivity analysis approach," International Journal of Production Economics, Elsevier, vol. 229(C).
    4. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 686-702, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    benefit-cost analysis; net present value; sensitivity analysis; social cost of carbon; regulatory analysis;
    All these keywords.

    JEL classification:

    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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