Finance Leasing Manual - FLM6.39

Use of 'net present value' computations

In theory, at least, no significant business investment decision should be made without using 'net present value' techniques for analysing the financial consequences, see FLM6.14. But human judgment is still often more important.

The future cash-flow projections of (say) Eurotunnel call for a considerable degree of guestimation. The crucial unknowns are the future receipts but there are other critical uncertainties, such as how long the assets will last, the size of the maintenance bills and the chances of disasters (such as a fire). Who could tell before the tunnel was dug how many people would use it in the years ahead and at what price? There still remains great uncertainty about future earnings and whether they will repay the enormous loans taken out by Eurotunnel.

The impressive output of a complex computer model can be very misleading. The most sophisticated computer model of an investment proposal always depends on estimates. But computations based on best estimates (or a range of estimates) can at least give a framework for exercising judgment. The computations can also identify those variables which are most crucial to success or failure. In practice, decisions may be based, wholly or partly, on intuition, guesswork or blind acts of faith.