An Alternative Method to Calculate The Net Present Value of a Multidivisional Firm’s Individual Project
No Thumbnail Available
Authors
Khamis M Bilbeisi
Chung Beak
Issue Date
Type
Journal Article, Academic Journal
Language
Keywords
Alternative Title
Abstract
The conventional NPV method has two inherent problems. The first problem is that of estimating future cash flows generated by an individual project under conditions of uncertainty and the other problem is that of selecting an appropriate opportunity cost of capital as a discount rate. Once a firm’s division estimates its divisional cost of capital, the division usually adjusts the divisional cost of capital for its individual project according to the individual project’s own risk level. This paper proposes an alternative method to calculate the net present value of a multidivisional firm’s individual project which reflects the failure possibility of the individual project. None of previous studies clearly attempted to incorporate the failure possibility of the individual project in a probabilistic closed-form. We demonstrate how our method works using a simple example. The method presented in this paper contributes to the refinement of existing NPV calculations.