Question

what are some examples of projects that companies would/must undertake that have a negative Net Present Value? HINT - think regulatory, especially environmental regulations!

Answer 1

A capital budgeting decision is by and large dictated by numerical considerations. However various qualitative considerations are also involved such as those mentioned below. Because of these considerations, a company may select an investment against their investment criteria or drop a project that otherwise meet their investment criteria. They may end up choosing a project with negative NPV. Reason can be:

• Environmental concerns: Water being generated as waste may be hazardous. If dumped without treatment, may lead to loss of lives of plants and animals near the dumping pond. Setting up the treatment plant will cost a lot, making the project NPV negative. The firm may still do it on the basis of environmental grounds.
• Regulatory environment: Regulations force you to make a corporate social responsibility project everytime you set up a manufacturing facility in the suburbs. The firm is required to develop roads, set up a school and a medical center in that area. The project may turn NPV negative because of these costs, but the firm will still have to undertake it.
• Reputation:
• Alignment with the long term strategy, mission and vision
• Urgency
• Employees’ morale
• Investors and customers image
• Legal matters
• Business and professional ethics: may not allow a company to enter into businesses like gambling, casino, lottery etc. even if they generate rate of return in excess of hurdle rate.
• Safety and health issues: a company decides not to enter into a terrorism prone area even if the project guarantees a handsome return
• Company culture