4. Adjusted Present Value (APV)

As a result of the raising focus on sustainability, several markets or quasi-markets have emerged, on which traditionally non-financial factors such as carbon emissions can now be exchanged. Thereby, these factors attain a "market" value and can be reflected in a capital budgeting framework that is similar to the standard NPV analysis.

  

The most prominent initiative for such a market mechanism is the "Carbon Pricing Leadership Coalition (CPLC)", which was officially launched in Paris in 2015. As of 2018, the CPLC includes 33 national and sub-national government partners as well as a large range of NGOs, private partners, business organizations, and universities. The goal of the CPLC is to internalize the costs associated with carbon emission by applying a carbon price throughout the global economy. By 2030, the coalition wants to cover 50% of global emissions.

 

In what follows, we briefly introduce this capital budgeting framework with a simple example. Then we discuss the application of the framework in a broader context. In sum, the proposed Adjusted Present Value (APV) procedure is as follows:

 

  1. Conduct a standard NPV-analysis that relies on market prices. Only reflect the factors that have a binding and objective market price. The result is the so-called base case valuation.
      
  2. Conduct a second NPV analysis for all the factors for which there is a non-binding market or quasi-market price. Participation in these "markets" is voluntary, so that there is no legal obligation to actually pay a full price for the factors in question. A case in point are the carbon emissions mentioned above or a voluntary extension of maternity and paternity leave. 
     
  3. The Adjusted Present Value (APV) of the project corresponds to the base case valuation plus the present value of the factors for which there is a non-binding market price:
     
    Adjusted Present Value (APV) = Base Case Valuation + PV of Factors with Non-Binding Market Prices.
      
  4. Discuss mostly qualitatively what additional non-financial factors are relevant, which have not yet been discussed under steps (1) or (2) above (see before).

 

Let's look at a simple example.