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ACCA Strategic Professional · Advanced Financial Management · Strategic business and financial planning for multinational organisations

A multinational is evaluating a project in a country where the government has announced a possible carbon tax that would raise operating costs, though timing is uncertain. In strategic planning, which approach best deals with this environmental policy uncertainty in the project appraisal?

The best approach is to model scenarios and sensitivities for the possible carbon tax and to recognise real options such as delaying or abandoning the project. Ignoring uncertain policy, adding the tax rate to the cost of equity, or switching to ARR does not properly capture the risk.

  1. ABuild scenario and sensitivity analysis on the carbon tax outcomes, and consider a real option to delay or abandonCorrect
  2. BIgnore the tax until it is legislated, since only certain cash flows may be included in NPV
  3. CAdd a fixed premium to the cost of equity equal to the proposed tax rate
  4. DReplace NPV with the accounting rate of return to avoid forecasting

Explanation

Uncertain policy outcomes are best handled by scenario or sensitivity analysis of cash flows and by recognising flexibility (options to delay or abandon) that has value. Ignoring the tax understates risk. Adding the tax rate to cost of equity mixes a cash-flow item with a discount rate. ARR does not remove the need to forecast.

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