Sensitivity analysis / Research note
Show What a Discount Rate Does to a Climate Project
Treat the discount rate as a visible assumption about time, risk, financing, and perspective.
Discounting converts future amounts into a present value. In a climate project, the choice can strongly affect long-lived infrastructure, energy savings, avoided damages, decommissioning costs, and benefits that occur after the financing period. The rate is not a neutral formatting choice. It combines assumptions about time and, depending on the method, risk and financing.
The first task is to state what is being discounted and from whose perspective.
Separate the perspectives
A project sponsor can evaluate cash available to equity. A lender can focus on debt service. A public analyst can compare social costs and benefits. These perspectives can use different cash flows, tax treatment, financing costs, and treatment of external effects.
Do not place a private weighted average cost of capital into a social cost-benefit calculation without explaining the change in meaning. Write the perspective, price basis, currency, and tax basis at the top of the model.
Keep real and nominal values consistent
Nominal cash flows include expected inflation and need a nominal discount rate. Real cash flows exclude general inflation and need a real rate. Mixing them can materially change the answer while leaving the spreadsheet visually plausible.
Treat carbon prices, electricity prices, wages, and technology costs separately. A general inflation assumption does not describe how every input changes. Record whether each series is nominal, real, indexed, or scenario-derived.
Avoid counting risk twice
Risk can enter through the cash flows, the discount rate, scenario weights, or a separate adjustment. If a downside scenario already lowers output and raises costs, adding a large rate premium for the same risk can count it twice.
Use explicit scenarios for risks that change the shape or timing of cash flows. Use the rate only for the role defined by the valuation method. Keep a short risk-to-model map so each risk has one main treatment.
Show the timing effect
Calculate the present value of each major category by year. A single net present value hides whether the rate mainly reduces late benefits, late costs, or both. Long construction periods and back-loaded benefits deserve separate attention.
Asset life and terminal value can dominate the result. State the physical life, economic life, model period, residual value, and decommissioning treatment. Do not use a terminal value to hide an unsupported forecast beyond the explicit period.
Run a structured sensitivity test
Use a central rate and reasonable alternatives that have a stated basis. Change one assumption at a time first. Then test combinations that can occur together, such as a higher financing cost and a construction delay.
Report the break-even rate only when the cash-flow pattern supports a clear interpretation. Projects with cash-flow signs that change more than once can produce misleading or multiple internal rates of return.
Keep climate effects visible
If avoided emissions or resilience benefits are not monetized, report them beside the financial result with their own units and boundary. If they are monetized, show the quantity, price or damage value, timing, and discount treatment. Do not let a present-value total erase the physical result.
The conclusion should show a range and the assumption that drives it. A project is not “uneconomic” or “attractive” in the abstract. It has a result for defined cash flows, perspective, period, and rate. Making those terms visible lets another reader test the decision instead of trusting one cell.