How to Evaluate Capital Projects that Offer Environmental/Carbon Reduction Benefits

Introduction

Environmentally influential capital investments have started to gain significant attention in the literature, due to the increase of pressures by various stakeholders on organisations and industry to be more proactive with regard to environmental sustainability in their processes, products and practices (Zhu and8 Sarkis, 2007).

The importance of environmental sustainability has been raised in the literature. Sarmento et al., (2005) found that 92% of Portuguese companies made “environmental investment because of the negative impacts of probable ecological accidents”. They also found that a large part of this investment was in tangible capital assets. If, for example, we look at the water industry, agricultural emissions in parts of France have increased in recent times to become a serious threat to water quality (Ekins, 2003). However, traditional appraisal models are inappropriate in such a uniquely regulated industry (Tebbutt et al., 2003).

It has also been recognised that the myriad of subtle ways environmental issues impact companies cost and revenue streams is often a first step in developing a proactive environmental management program (White, 1996). The limitations existing with various investment appraisal approaches when it comes to environmental issues, including the need to incorporate strategic considerations into corporate decision-making, planning and control processes, has long been recognised by environmental accounting researchers (Burritt, 2004; Burritt and8 Saka, 2006). The mainstream academic literature on investment appraisal appears to focus on traditional financial evaluation techniques and tools with little recognition of environmental issues as a factor in the decision process of organisations (Ross and8 Wood, 2008).

It has been empirically found that environmental benefits accrue over a much longer time-horizon than typical investments in organisational projects (Regnier and8 Tovey, 2007), making their inclusion into investment appraisal and justification even more difficult. In addition to long time planning horizons, there are issues with the various costs and benefits that are associated with green decisions and factors. The United States’ Environmental Protection Agency’s (USEPA) well known cost categorisations (USEPA, 1995) include conventional, hidden, contingent, relationship/image, and societal costs, which range, respectively, from easier to measure to most difficult to measure categories. Thus, there will also be a mixture of relatively tangible traditional costs to less tangible and non-traditional cost categories. It is difficult to integrate these characteristics of environmental costs into traditional capital investment appraisal tools.

There is therefore a need for tools that can effectively help organisations make decisions concerning capital projects that include environmentally sustainability dimensions. Organisations need to make a ‘business case’ for such projects, irrespective of whether they are initiated through regulatory or competitive pressures. One solution is the adoption of the financial appraisal profile approach.