1. Introduction

We have argued that managers should use market prices when estimating the incremental net cash flows of a project. If all of the resources that a project uses are valued at "fair" market values, we can be confident that the resulting NPV also constitutes a "fair" market value.

  

In reality, as we have already pointed out in the discussion of the NPV rule, the NPV of a project will not always provide a complete picture of its true impact on social welfare. For example, the project could have important side-effects that are difficult to quantify financially or it could use resources that have no binding market price to begin with.

 

In this section,

  • we start with a brief overview of a two-pronged valuation approach that managers should follow when deciding about capital investments. In doing so, they can incorporate both financial and non-financial goals in their capital budgeting decisions.
     
  • Then, we show how to adjust the standard NPV calculations for important side-effects of projects, for which there are market (or quasi-market) solutions available, in particular the emission of carbon dioxide.