Valuation of investment projects, sustainability, and its implications on the cost of capital

Abstract

The objective of this study is to analyze the impact of sustainability on the cost of equity (CoE) within the investment valuation process. It considers the hypothesis that sustainability practices help reduce a firm's perceived risk, thereby influencing the required rate of return and, consequently, the discount rate. This analysis is critical to understanding the relationship between sustainability practices and corporate financial decision-making, particularly in relation to CoE and investment valuation. The study presents a critical perspective, challenging the notion that sustainability practices undermine financial value. It also proposes a valuation methodology that incorporates sustainability by adjusting the discount rate, thereby influencing firms’ investment valuations. This approach addresses the need to develop more robust methods for integrating sustainability into CoE analysis, enabling companies to reconcile stakeholder demands for sustainability with financial requirements.