Project Net Present Value estimation under uncertainty

Abstract

The paper contains a description of a possible modification of the original Net Present Value which allows one to evaluate projects under uncertainty with unknown probabilities (understood mainly as frequencies). Cash flows are usually uncertain since both incomes and expenditure related to the project concern the future. Additionally, probabilities of particular scenarios may be unknown due to many factors (e.g. the diversity of definitions for probability, lack of historical data, lack of sufficient knowledge about possible states of nature). The novel approach is based on a hybrid of Hurwicz and Bayes decision rules and is supported by a sensitivity analysis. The new method applies scenario planning and takes into account the decision maker’s attitude towards a given decision problem (measured by coefficients of pessimism and optimism). The procedure can be used even in the case of asymmetric distributions of net cash flows at particular periods since it considers the frequency of each value. The modification of the Net Present Value may support any uncertain multi-period economic decision.