The Finance of Environmental Investments

Abstract

A proper selection and valuation of investment (or disinvestment) projects is crucial for financial managers. This is particularly difficult in the context of risks, globalization of economy, technology changes, strong competition, and in the presence of information asymmetry and environmental constraints. In the last context, it is essential for governments to decide which policy to adopt in response to a threat to the environment and when to implement it. The decision making tool usually recommended by the corporate finance theory is the so called NPV (Net Present Value) approach. This conventional approach, generated by the neo-classical theory, does not fulfill the needs as it ignores the flexibility inherent to the decision making process and the dynamic aspects of project selection. As shown in this chapter, the real options approach provides a new and powerful decision making tool that overcomes the limitations of the traditional DCF (Discount Cash Flow) method, and permits a more appropriate valuation of investment projects related to the environment in particular.