As I have previously said, the number of problems and inaccuracies of the “Net Present Value” method, when used in a “Company based scenario”, is legion. One can have a field day poking holes in the credibility of even the most carefully prepared work. Just for the fun of it, let’s mention a couple more.
At Fiscal Year end, the profit is distributed into income tax, dividends, reserve funds and retrained earnings. The income tax and the dividends are sums that will be paid, and accordingly constitute new cash flows. The retained earnings and the reserve funds do not get paid, and accordingly are sums that remain in the company’s Bank account. So in some days they increase the positive balance (more “Interest Income” at 0.50%), in some other they decrease the negative balance (less “Interest Expense” at 6.00%), and in some other they are the deciding factor that turns a negative balance into a positive one. Their effect in the results of the next Fiscal Years cannot be incorporated into the calculation, because the “Net Present Value” method does not foresee in any of its steps the determination of a daily balance of the bank account. The same effect exists for income tax and the dividends, until their payment date. Again their contribution (“Interest Income” and “Interest Expense”) is impossible to be taken into account thru the NPV method.
There are tax laws (example: Greek Tax law 128/75) who’s basis of calculation is the daily balance of the bank account, and also take into consideration whether that daily balance is positive or negative. Since the NPV method does not calculate the daily balance of the Bank account, any calculation of cash flows resulting from such laws is practically impossible.
I’m sure that if you give it a little thought, you can easily come up with a dozen other problems.
Stick around, and we are going to see how professionals throughout the world do their work, and that in order to avoid the problems of the “Net Present Value” method, they took a step back in evolution of Financial Analysis calculation methods.
