CFA Level I · CFA Level I Exam · Company Analysis: Past, Present, and Future
An analyst incorporates ESG factors into a valuation of a mining company with a history of environmental violations. Which adjustment is most appropriate?
The most appropriate adjustment is to raise the discount rate or reduce forecast cash flows to reflect potential fines and remediation costs. Environmental violations create financial risk, so ignoring them or lowering the risk premium would overstate the company's value.
- ALower the equity risk premium for the sector
- BIgnore the violations because they are non-financial
- CRaise the discount rate or reduce forecast cash flows for potential fines and remediationCorrect
Explanation
Environmental risks can lead to fines, cleanup costs, and licence loss, which affect cash flows and risk. These should be reflected in forecasts or the discount rate. Ignoring them or lowering the premium would overstate value.
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