Capital Budgeting: Some Exceptions to the Net Present Value Rule

Textbooks tend to emphasize the net present value (NPV) rule, often arguing that it is theoretically superior to other methods. Yet other methods, many of which do not involve discounting, are also used in practice. Hence, one of two conclusions can be drawn: (1) firms are making suboptimal decisions or (2) the assumptions underlying the NPV rule are not always met in practice. The purpose of this paper is to present simple numerical examples wherein applying the NPV rule leads to erroneous decisions. The examples highlight the assumptions underlying the NPV rule.