Why would some investment activities have a positive NPV?

• Buyer preferences for established brand names.
• Ownership or control of distribution system.
• Patent control of product design or production technique.
• Exclusive ownership of superior natural resource deposits.
• Inability for new firms to acquire necessary factors of production.
• Superior access to financial resources at lower costs.
• Economies of large scale production & distribution due to capital-intensive production process or high initial startup costs.

Measurement of Risk
The problem in NPV is that it does not provide a clear means of estimating risk. For example, how sure are we that the investment will be worth 1,200,000 at the  end of the year?  What if it turned out to be far less than 1.2 million?  Managers therefore have to evaluate investment risk and translate it into the discount rate (RRoR) to reflect adequate compensation.  We therefore need to show probabilities for the return.

Suppose in the land investment example, we are not very confident on the $1.2 million?  We can compensate for the perceived risk by requiring the ROI to be, say 19% instead of 9%.

Calculation using 19% will be 1.2 x 1/(1 + 0.19) = $1,008,403.

Therefore, the NPV is 1,008,403 – 1,000,000 = $8,403
Thus, high risk reduces NPV from 100,917 to 8,403.
Given the positive NPV, it will still be economical to invest in the land.