Common Use of the Net Present Value (NPV) Criterion for Project Evaluation: A Cause of Allocative Inefficiency
Journal Title: Research Journal Social Sciences (Online) - Year 2017, Vol 6, Issue 2
Abstract
To evaluate competing investment projects, corporate managers generally use the NPV criterion. Their choice is justified from the perspective of shareholders assuming unlimited supply of funds for a firm. Their choice, however, cannot be justified for a country which has limited supply of funds. This research therefore highlights negative externality of the common use of NPV criterion. By taking numerical examples, this research first illustrates that the NPV criterion is biased against small-size and short-term projects even if they are more efficient as per the IRR criterion. Then assuming a fixed supply of monetary capital for the country, it proves that this biasedness leads to allocative inefficiency in the country. The policy implication is that this externality may be researched further in order to develop a better criterion for project evaluation.
Authors and Affiliations
MUHAMMAD MAZHAR IQBAL
Keywords
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