Providing decision makers and the investment community with transparent methods to value investments in resilience and adaptation measures to protect physical assets from climate change impacts is becoming increasingly critical. To address this need, this paper introduces and utilizes the decoupled net present value (DNPV) valuation methodology.
DNPV is a robust method that can incorporate climate change risk into investment analyses. This paper also discusses how the widespread use of traditional valuation methods such as net present value combined with risk-adjusted discount rates introduces a pernicious time bias effect that magnifies stakeholders' misaligned interests and investment horizons, leading investors, both public and private, to significantly underinvest in resilience and adaptation. Furthermore, because traditional valuation methods cannot correlate physical risks (e.g., loss of revenue due to physical damage or lost access to an asset) with discount rates, investments to reduce climate change risks are largely considered as expenses that make the investment less attractive. The DNPV method addresses this issue and offers a viable alternative that can consistently and transparently quantify all risks (market and non-market) in terms of cash flows. This allows investors and stakeholders to quantify in monetary terms the potential exposure of physical assets to climate-related hazards and assess the effect of decisions to invest in resilience and adaptation measures. With the aid of a simple numerical example, the DNPV method is used to illustrate how such actions can be treated as quantifiable risk reduction investment opportunities that result in better investment decisions.
- Geosyntec Authors: David Espinoza, Ph.D., P.E. and Jeremy Morris, Ph.D., P.E.
- All Authors: David and Jeremy's coauthors are Hiba Baroud, Ph.D., Vanderbilt (Tennessee); Marcelo Bisogno, Inter-American Development Bank (Washington D.C.); Arturo Cifuentes, Ph.D., Columbia Business School (New York); Anastassios Gentzoglanis, Ph.D., Université de Sherbrooke (Quebec); Laurent Luccioni, Ph.D., PIMCO; Javier Rojo, Sustainability Strategic Advisors (London); and Farshid Vahedifard, Ph.D., P.E., Mississippi State University (Mississippi).
- Title: The role of traditional discounted cash flows in the tragedy of the horizon: another inconvenient truth
- Event or Publication: Mitigation and Adaptation Strategies for Global Change
- Practice Areas: Water and Natural Resources
- Citation: David Espinoza, Ph.D., P.E. and Jeremy Morris, Ph.D., P.E. (Maryland) coauthored a paper entitled "The role of traditional discounted cash flows in the tragedy of the horizon: another inconvenient truth" for publication in Mitigation and Adaptation Strategies for Global Change on July 29, 2019.
- Date: July 29, 2019