- with sustainable (green) bond issuance growing five-fold over the previous five years 11 - to address this shortfall will still require mainstream capital markets to engage with the SDGs at a scale beyond the current levels. A key priority is to increase exposure to developing economies by expanding the investable universe beyond green bonds to include the health, education, and social development sectors. In this context, we suggest that there is a market failure in the efficient allocation of capital, consequent on incomplete investment analyses that systematically undervalue material investment risks and opportunities in the longer-term. 12 Specifically, this paper offers a critical analysis of the Net Present Value model.
Net Present Value Model (NPV)
In the presence of efficient financial markets, Net Present Value (NPV) is a core concept for the investment decision-making process in which future costs/benefits (often manifested as cash flows) are discounted to their present value. Fisher’s seminal works, The Rate of Interest (1907) 13 and The Theory of Interest (1930) 14 formalized foundational principles, including the time value of money (TVM) that laid the foundations for subsequent economic debates about future value, which is discussed in this paper. The justification for discounting future cash flows at a given discount rate ( r ) reflects two dominant logics related to consumption and investment. Firstly, economists assume rising consumption over time, which leads to diminishing marginal utility 15 and secondly, that investments tend to yield a positive return 16 . This leads to the assumption that $1 today is worth more than $1 in the future and so we discount this future benefit to account for the opportunity cost. Risk, in its various forms is also captured within the term r . The Discounted Cash Flow (DCF) method calculates the present value of cash flows within the investment horizon and beyond, incorporating a Terminal Value (TV) perpetuity 17 for long-term projections (see below). While DCF serves as a valuation technique, the NPV model acts as a decision-making tool, guiding capital allocation by evaluating the present value of discounted cash flows net of the initial investment. The objective of this analysis is to identify investments that yield the maximum NPV whilst comparing alternative investment opportunities, to optimise asset/resource allocation, support long-term investment decisions, consider all revenues/costs, account for the time value of money, consider risk and cost of capital, determine break-even discount rates and to run sensitivity and/or scenario analysis over the forecasted period. The NPV formula is represented as follows: Developments-Global-Longer-term-Forecast-to- 2033.html#:~:text=Sustainable%20Finance%20Market%20Projected%20to%20Reach%20%246.71%20Trillion%20in %202024,Long%2Dterm%20Forecast%20to%202033 11 https://sdgpulse.unctad.org/investment-flows/#Ref_3UN5E29U. 12 These are typically treated as ‘externalities’ that are not a material to NPVs calculations with a short-term time horizon. 13 See: Veblen, T., 1909. Fisher's rate of interest. Political Science Quarterly , 24 (2), pp.296-303. 14 Fisher, I., 1913. The impatience theory of interest. The American Economic Review , 3 (3), pp.610-618. 15 The economic principle that states as a person consumes more units of a good or service, the additional satisfaction or utility they derive from each successive unit decreases. 16 Costanza, R., Kubiszewski, I., Stoeckl, N. & Kompas, T., 2021. Pluralistic discounting recognizing different capital
contributions: an example estimating the net present value of global ecosystem services, p. 3. 17 Ganti, A. (2023). Terminal Value (TV) Definition. [online] Investopedia. Available at: https://www.investopedia.com/terms/t/terminalvalue.asp.
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