It has long been recognised that applications of the
Net Present Value (NPV) investment decision making
methodology can have serious deficiencies in situations
where investment can be delayed and, once made,
various options allow increases or decreases in the level
of output. NPV valuation can undervalue the project if
it does not incorporate future flexibilities or ""options"".
It is important to realise that a proper valuation of a project (ie, valuation of its future cash flows) must
incorporate an analysis of optimal future decisions
involved in managing the project. Current valuation
cannot be divorced from a consideration of future
decision making. There is now a considerable amount of literature,
mainly academic, identifying and exploring ways of
remedying these deficiencies in the application of NPV.
While the necessity of period by period analysis is
sometimes acknowledged, little if any practical
illustrative model building has been published to date,
aside from algorithms using continuous time stochastic
processes which deny access to the uninitiated.