Combination of survival probabilities of the components in a system. An application to long-term financial valuation

Abstract

The Net Present Value (NPV) is a well-known method to value an investment project. Nevertheless, this methodology exhibits a serious problem when the used discounting function decreases very rapidly, especially in (very) long-term projects, because the future cash-flows are not significant in the expression of the NPV. For this reason, this paper introduces a methodology to correct the discounting function used for valuing. To do this, a new operation between discounting functions is defined by reducing the (cumulative) instantaneous discount rate corresponding of the valuing discounting function with another appropriate discounting function. The result is a new discounting function which can be more adequate to value this class of investment projects.