Reconsideration of the present value method

Abstract

In investment decision-making, the net present value method is widely used as one of the best decision rules (techniques or criteria). At the same time, it is also used to evaluate decision alternatives for a long range period of time, in economics or even in control theory. Its theoretical validation as the best method for investment decision-making has been based on a basis such that the best technique (investment decision rule) will maximize shareholders' wealth which is measured by the present value of cash flows discounted at the opportunity cost of capital. Such a theoretical requirement as maximizing shareholders' wealth is very important for investment decision-makings. This requirement implies that an ordering relation of projects determined by the best investment rule must be order-isomorphic to that determined by the measure of shareholders' wealth. This order-isomorphism can be represented by necessary and sufficient conditions (or separate criteria). However, they are not suitable for comparing investment decision rules, because they are designed for selecting the best investment decision rule. At the same time, the other dominance of the net present value method over other investment rules is also found in its decision-theoretical aspects. Formulating the net present value method, internal rate of return method and simple sum method in an axiomatic fashion, the net present value method is compared with the other rules, and is shown to have enough clarity and simplicity in theory and practice.