Using Incremental NPV to Compare Infrastructure Costs
Summary
The document explains how to use net present value when evaluating a public project that generates no direct revenue. Its example compares rebuilding a road with continued maintenance, where both options may have negative standalone cash flows. The suggested approach is to compare the difference between the alternatives: count the rebuild cost up front and the maintenance savings it produces over time, then discount those incremental flows.
The decision depends on the value of the savings relative to the project’s funding cost. One answer recommends including the borrowing cash flows and proceeding if the resulting NPV is positive; another notes that if both alternatives truly have negative NPVs, the less negative one is preferable. The discussion also suggests using IRR as an alternative comparison, while emphasizing that the appropriate discount rate can be difficult to determine for public or noncommercial projects. It offers a framework and illustrative figures, not a full appraisal method for uncertainty, social benefits, or project risk.
Key ideas
- NPV can compare alternatives that produce cost savings instead of direct revenue.
- Evaluate incremental cash flows by comparing the rebuild cost with future maintenance savings.
- Include financing costs or compare the project’s IRR with its borrowing rate.
- When both choices have negative NPVs, the less negative alternative may be preferable.
- The discount rate remains a key judgment, especially for public projects.
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Full text
# Modelling NPV with negative cashflows? # Modelling NPV with negative cashflows? When making capital investment decisions that have cost saving implications instead of cash flow generation, is NPV still valid? For example: A state wishes to decide whether to replace a section of road (giving it a new lifespan of 30 years) or keep maintaining at. Both scenarios would have no positive cashflows as the stretch of road does not generate revenue, and both NPV's would be negative. Would NPV still be valid to assist in this decision making? ## Answer by D Stanley (score 1) https://quant.stackexchange.com/a/50723 For this type of analysis you'd look at the cash difference - meaning how much cash does it save by rebuilding the road versus maintaining it. The calculate the NPV of that savings, less how much it would cost to borrow the initial outlay. So if the road cost \$10 Million in year 0 to build but saved \$700,000/year in maintenance over 30 years, you'd have an initial cash flow of -10,000,000 and cash flows of +700,000 over the next 30 years. You'd then subtract the cash flows of the bond used to fund the project. If the NPV of those cash flows is positive, then you'd do the project. Alternatively you could look at the IRR of the cash flows without the bond. Then you could say you'd have to borrow money for less than that rate to make the project viable. ## Answer by Acccumulation (score 0) https://quant.stackexchange.com/a/50352 > When making capital investment decisions that have cost saving implications instead of cash flow generation, is NPV still valid? Yes, although you may need to reevaluate your discount factor. > Both scenarios would have no positive cashflows as the stretch of road does not generate revenue Presumably, there is some value, otherwise they wouldn't be doing it. Even if they're not directly getting money, they should be able to put a dollar amount on what they think it's worth. If they're uncertain what amount to put, then this uncertainty should be factored into the discounting. > both NPV's would be negative If the NPV truly is negative, then you would want to take the least negative NPV. ## Answer by demully (score 0) https://quant.stackexchange.com/a/50734 Yes, absolutely. It makes no difference to the NPV framework whether you look at opportunity costs and benefits rather than absolute or net cashflows. The tricky thing here is what you then mean by the IRR/discount rate/time preference. Let’s say I am involved in international aid. I could spend a lot today in a big project that might make a big difference, reducing my future commitments (which are small but perennial in the alternative scenario). The trade-off between imminent big cashflows and a stream of smaller future cashflows the other way (or vice versa) is no different than any corporation assessing a potentially profitable investment. No different at all. What’s often less clear-cut here is the appropriate discount rate. What is the “cost of capital” of international aid?
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.