How can an organization possibly know whether an investment in an economically, environmentally, or socially sustainable project is worthwhile? For instance, how can it place a value on a flex time policy that reduces rush hour traffic? Or on an energy policy that shifts from a carbon based fuel to a renewable source? Or on a charitable contribution that supports a local hospital?
That may have been the question that generated the most “buzz” among the attendees at last week’s First Annual Conference on Sustainability in the Big Apple. Co-sponsored by the New York Hedge Fund Roundtable and the New York State Society of CPAs, the Conference attracted financial professionals from around the world to ponder such weighty concerns.
It’s a very important consideration because, if organizations aren’t able to value such expenditures, they may easily decline to make them. And without such expenditures, we might find ourselves confronting numerous situations of economic decline, environmental crisis, and social unrest.
Many organizations are addressing this question by defining complex models and metrics for measurement purposes. The Global Reporting Initiative, for instance, has now issued its fourth generation (i.e. its G-4) of sustainability standards. And the Sustainability Accounting Standards Board is doing similar work for more than eighty industries throughout ten organizational sectors.
Sometimes, though, it can be helpful to rely on traditional approaches to solve contemporary problems. After all, even if such approaches cannot provide comprehensive solutions, they can offer the universal tools and techniques that we can utilize to address our challenges.
So, with this in mind, here is a question: can the simple Net Present Value method help us place values on sustainability expenditures? The NPV calculation was first formalized in Irving Fischer’s landmark 1907 text The Rate Of Interest. Although it is more than a century old, it still serves as the contemporary investment industry’s favorite valuation method.
Basically, NPV values an investment as the sum of the (discounted) future cash flows that can be attributed to it. Cash flows that occur later (i.e. in the relatively remote future) are discounted by a greater extent than cash flows that occur earlier (i.e. in the near future) in order to account for uncertainty and the ability of investors to accrue interest income over time.
So how would we apply this concept to investments in sustainability projects? Well, organizations that invest in flex time programs, renewable energy sources, and local hospitals would be helping people, societies, and organizations conserve and generate resources. The future value of such resources, discounted appropriately to the current year, would represent the Net Present Value of such expenditures.
Is there anything wrong with such an approach? Of course, reasonable people may raise all sorts of concerns about it. For instance, individuals with a deep sense of morality and religiosity may protest that this technique (perhaps disturbingly) expresses charitable impulses in purely financial terms.
But if we need to start somewhere, why not start with NPV, the most commonly utilized valuation metric of the past century of financial analysis? On the one hand, it may strike us as a somewhat simple option. But on the other hand, as Friar William of Ockham once taught us, it may be wise — as a general rule, or “razor” — to prefer simpler scientific constructs to more complex ones.