Embedded Discounting and the Green Transition

45 Pages Posted: 21 Apr 2022

See all articles by Daniel Møller Sneum

Daniel Møller Sneum

Technical University of Denmark

Emilie Rosenlund Soysal

Potsdam Institute of Climate Impact Research (PIK)

Frikk Nesje

University of Copenhagen - Department of Economics

Mark C. Freeman

Loughborough University

Abstract

Net Present Value (NPV) calculations feature centrally in the economic appraisal of potential Green Transition investments, yet their high sensitivity to the choice of social discount rate (SDR) is an issue of material concern for project analysis. Considerable attention is routinely given to the SDR that explicitly features within the denominator of the NPV equation, yet discount rates are also less obviously embedded within various components of the NPV’s numerator. Taking a recently proposed geothermal district heating plant in the Danish city Aalborg as the basis for a case study, we question whether there is consistency in the choice of SDR across all elements of the economic and financial appraisal of Green Transition projects. While the NPV’s denominator reflected a real SDR of 3.5 percent, in keeping with Danish government guidance, emissions and electricity prices were based on carefully justified, yet different, costs of capital, as did the annuity rate applied in the financial analysis of the project. The use of corporate rates that are substantially higher than standard estimates of the SDR in some contexts potentially makes it more difficult for Green Transition projects to meet the legal requirement of being evaluated as socio-economically optimal.

Keywords: Social Discounting, Net Present Value, Socio-Economic Analysis, Geothermal, District Heating

Suggested Citation

Møller Sneum, Daniel and Rosenlund Soysal, Emilie and Nesje, Frikk and Freeman, Mark, Embedded Discounting and the Green Transition. Available at SSRN: https://ssrn.com/abstract=4089463 or http://dx.doi.org/10.2139/ssrn.4089463

Daniel Møller Sneum (Contact Author)

Technical University of Denmark ( email )

Anker Engelunds Vej 1
Building 101A
Lyngby, 2800
Denmark

Emilie Rosenlund Soysal

Potsdam Institute of Climate Impact Research (PIK) ( email )

Telegrafenberg 31
Potsdam, Brandenburg 14473
Germany

Frikk Nesje

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5, Bygn 26
Copenhagen, 1353
Denmark

Mark Freeman

Loughborough University ( email )

Ashby Road
Loughborough, LE11 3TU
Great Britain
+44-1509-223107 (Phone)

HOME PAGE: http://www.lboro.ac.uk/departments/sbe/staff/profiles/freemanmark/freeman-mark-.html

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