Investment Appraisal in ESG: Evaluating Sustainable Investments
- Traditional investment appraisals focus on financial returns, how much profit an investment will generate.
- But ESG investing (Environmental, Social, and Governance) requires companies to also evaluate non-financial risks and long-term sustainability.
- Companies can’t just look at profitability, they have to consider climate impact, social responsibility, and governance risks.
- Ignoring ESG factors can mean regulatory fines, reputational damage, or stranded assets (e.g., fossil fuel investments becoming obsolete).
Note
Many companies underestimate the long-term financial risks of ignoring ESG factors, leading to massive losses when regulations tighten.
How Investment Appraisal Works in ESG
- ESG investments are assessed using:
- Net Present Value (NPV): Does the investment provide long-term financial returns while aligning with ESG goals?
- Payback Period: How quickly does a sustainable project recover costs?
- Internal Rate of Return (IRR): Does the return justify the risks of investing in green tech?
- Non-Financial Criteria: Carbon footprint, ethical sourcing, corporate governance, etc.
Example
A company investing in a solar energy farm may have a longer payback period than a coal plant but avoids future carbon taxes and benefits from government incentives.
Exam technique
In ESG investment appraisals, discuss both financial and non-financial factors, ESG risk can directly impact long-term profitability.
Case study
BYD's Investment in Battery Recycling
- In March 2018, BYD announced plans to open a battery recycling plant in Shanghai in the second quarter of that year.
- This strategic move aimed to reduce raw material costs and address environmental concerns associated with battery waste.
- The initiative was driven by rising costs of EV battery materials, such as lithium and cobalt, and a commitment to environmental protection.
Financial & ESG Investment Appraisal
| Factor | BYD’s Consideration |
|---|---|
| Initial Investment | ¥15 billion for R&D, plant construction |
| Annual Cash Inflows | ¥3.5 billion/year from recycled battery sales |
| NPV Calculation | Discounted cash flows show an NPV of ¥30 billion—a highly profitable project |
| Payback Period | 4.3 years (shorter than industry average) |
| Environmental Benefits | 50% lower carbon footprint than mining new materials |
| Regulatory Risk | Low—China's government supports battery recycling with subsidies |
Source: Reuters 2018
Hint
ESG projects often look less profitable short-term, but regulatory support and long-term cost savings make them financially superior in the long run.
