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Environmental Shareholder Value

13 Calculation example for the interplay between the environment and Shareholder Value

13.1 Investment in cleaner technology and the effect on EP
13.2 Resource efficiency and the effect on ROCE
13.3 Product liability (take-back obligation) and the effect on EBITDA

This chapter gives three examples of how the company's environmental conditions could impact Shareholder Value and how this could be underlined in the key figures.

All the examples are for the fictive company ESV A/S which produces electric appliances.

Below are the key figures from ESV A/S' 2003 annual report. The figures have been calculated on the basis of the income statement and the balance sheet which can be found in appendix A. These figures form the basis of the calculations of the significance of the environment for the Shareholder Value of ESV A/S.

Table: Key figures for ESV A/S as they appear without environmental economic calculations

13.1 Investment in cleaner technology and the effect on EP

In 2002, ESV A/S made an investment of DKK 6 million in cleaner technology.

The purpose of the cleaner technology was to reduce ESV's annual CO₂ emissions by approx. ten per cent. Since ESV A/S has a large own production of energy, the company will be subject to the EU's CO₂ emission allowance trading system. It is expected that ESV A/S will have a CO₂ emission allowance for 2005 onwards, which entails an obligation to reduce emissions by approx. ten per cent. If the investment had not been made, ESV would have to expect to buy allowances or, at worst, pay an allowance fee of EUR 40 per tonne for each of the years 2005-2007 and EUR 100 per tonne for the years 2008-2012.

We will now study the effect of the future savings on the investment and the Economic Profit (EP) for the investment year 2002. Since we do not know the market price for CO₂ allowances, ESV decides to apply the allowance fees that are known.

The table below shows the expected savings in allowance fees discounted to present value in the investment year 2002.

Click here to see table

The discounted value of DKK 3.255 million is deducted from the invested capital which would correspond to setting the investment of DKK 6 million at DKK 2.645 million, taking into account the saving from the investment.

The required rate of return on the invested capital is 8 per cent for ESV A/S, and as can be seen from the figures for the company (table 1), the net operating profit after tax (NOPAT) of ESV A/S in 2002 was DKK 46.1 million. On the basis of these figures, we have the following result:

Table: Comparison of Economic Profit including and excluding environmental saving

If the savings from the investment are taken into account, the EP thus becomes DKK 300,000 higher than in the traditional calculation.

13.2 Resource efficiency and the effect on ROCE

In 2002, ESV A/S implemented an optimisation process leading to a reduction in consumption of materials of 2 per cent. Moreover, the process entailed that the inventory of raw materials was also reduced by 2 per cent.

In order to assess whether the result was worth the investment, management decides to find out what the effect of the process was on the finances of the company. We calculate what ROCE and Economic Profit would have been in the optimisation had not been implemented.

Table: Calculation of traditional key figures and figures as they would have looked if the environmental project had not been implemented

As can be seen from table 4, the optimisation has entailed that:

• Net Operating Profit After Tax (NOPAT) has increased as a consequence of the reduced resource consumption.
• The capital employed has fallen as a consequence of the minimisation of the inventory.
• These two effects together result in an increase in ROCE of 2 per cent and 3 per cent in 2002 and 2003 respectively.
• In terms of improved Economic Profit, this means increased value of DKK 2.6 million and DKK 2.7 million in 2002 and 2003 respectively

13.3 Product liability (take-back obligation) and the effect on EBITDA

In 2002, ESV A/S made provisions of DKK 8 million for costs related to the implementation of the future directive on take-back schemes for waste electrical and electronic equipment. The directive means that the manufacturer becomes responsible for the financing of collection, treatment and disposal of end-of-life and scrapped products. The directive is not expected to enter into force until 13 August 2005, but it also includes collection of products sold before this date.

The provision was calculated on the basis of the 2002 revenue. The obligation to finance take-back of products sold before 2002 is disclosed in the annual financial statements as a contingent liability due to uncertainty as to the financial extent of the obligation. In 2003, the provision was adjusted to DKK 10 million due to the change in the 2003 revenue. In the long term, ESV A/S expects to be able to recover part of these costs through the sales price, but this has not been possible for 2002 and 2003.

The significance of the provisions for earnings, EBITDA and Economic Profit are calculated below.

Table: Calculation of key figures including and excluding take-back obligation

As can be seen, EBITDA would have been 0.8 per cent and 1.2 per cent higher if the company did not have to make this provision, and Economic Profit would have been DKK 5.3 million and DKK 6.6 million higher in 2002 and 2003, respectively.

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Version 1.0 April 2005, © Danish Environmental Protection Agency