Net Present Value

NPV is hard to estimate accurately, does not fully account for opportunity cost, and does not give a complete picture of an investment's gain or loss.

NPV has a number of disadvantages. Although NPV is still commonly used, firms will also use other metrics before making investment decisions.

The first disadvantage is that NPV is only as accurate as the inputted information. It requires that the investor know the exact discount rate, the size of each cash flow, and when each cash flow will occur. Often, this is impossible to determine. For example, when developing a new product, such as a new medicine, the NPV is based on estimates of costs and revenues. The cost of developing the drug is unknown, and the revenues from the sale of the drug can be hard to estimate, especially in the future.

Medicine Drug developers must calculate a drug's future revenues to find its NPV and determine whether it is worth the cost of development.

Furthermore, the NPV is only useful for comparing projects simultaneously; it does not fully build in opportunity cost. For example, the day after the company decides which investment to undertake based on NPV, it may discover there is a new option that offers a superior NPV. Thus, investors don't simply pick the option with the highest NPV; they may pass on all options because they think another, better option may come along in the future. NPV does not build in the opportunity cost of not having the capital to spend on future investment options.

Another issue with relying on NPV is that it does not provide an overall picture of the gain or loss of executing a certain project. To see a percentage gain relative to the project's investments, internal rate of return (IRR) or other efficiency measures are used as a complement to NPV.