Rimu Foods: Carbon Pricing in a Heat-Recovery Investment Appraisal
Rimu Foods Ltd processes dairy ingredients in Waikato. It is evaluating a $2.8 million heat-recovery project that would reduce natural gas use. Annual energy savings are estimated at $620,000 and incremental maintenance at $80,000. The project has a ten-year life and no residual value. Rimu uses a 9% real discount rate. The project would reduce emissions by 1,800 tCO2e per year. The company faces a carbon price of $75 per tCO2e under its internal shadow price, although it currently has no surrender obligation because it is below the ETS threshold. A major customer has asked for a 30% reduction in product carbon footprint by 2030 and may delist suppliers that do not show progress. The engineering estimate has a ±20% uncertainty; carbon price is expected to rise 5% per year in real terms. The CFO wants a conventional NPV and is unsure whether to include carbon. The sustainability manager argues that excluded carbon will misstate the decision. The board asks for a recommendation.
1. Calculate NPV with and without carbon at a constant $75 per tCO2e, and test the sensitivity of the energy-saving estimate.
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The ten-year 9% annuity factor is 6.4177. Without carbon, annual net cash flow is $620,000 − $80,000 = $540,000. PV = $540,000 × 6.4177 = $3.4656m; NPV = $3.4656m − $2.8m = $0.666m.
With a constant carbon value, the annual carbon benefit is 1,800 × $75 = $135,000. Net cash flow is $675,000; PV = $675,000 × 6.4177 = $4.332m; NPV = $1.532m. If energy savings are 20% lower ($496,000), net cash flow becomes $416,000; PV = $2.670m; NPV = −$0.130m. So the project is marginal on the energy case alone and only clearly positive with carbon included. If carbon rises 5% per year in real terms, the growing carbon annuity has a PV of about $1.053m, giving an NPV of about $1.719m.
2. Discuss whether and how the carbon price should enter the appraisal, and recommend a decision with governance conditions.
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The $75 shadow price is not currently a cash flow because Rimu has no ETS surrender obligation. Including it as certain cash would overstate the financial return. Excluding it entirely would understate strategic risk, because the customer’s 2030 footprint requirement and possible delisting are real commercial exposures. The better approach is scenario analysis: base case without carbon, a constant shadow-price case, a rising-price case and a customer-loss case. The board should disclose which cash flows are contractual and which are strategic. The 9% real rate should be checked for consistency with the carbon assumptions; if carbon risk is systematic, a risk premium may be justified.
Given the −$0.130m NPV at 20% lower energy savings, the project is not robust on energy alone. A conditional approval is defensible: proceed to detailed engineering, secure a customer commitment or green-finance benefit, and set stage gates. The board should monitor actual savings, carbon price and customer requirements, and avoid presenting the shadow-price NPV as a certain cash outcome.