CFO based on a NPV and ROE analysis

You are the environmental manager of a large forest products company. This company owns a forest that it has chosen to selectively harvest for trees. The company has been in business for four generations due to sustainable forestry methods. Because of its prudent management, the company has very little debt, and it does not earn enormous profits. The company consistently delivers a 9 percent return on equity (ROE) to shareholders, considered below average for the forest products industry.

World financial markets have heated up, and it is now possible to purchase AAA-rated bonds that yield 11 percent (this can be considered the cost of capital and the discount rate). Home building has declined and the price of lumber is 30 percent lower than in previous years. This drop in price has caused the company- ROE to drop to 6 percent, and its stock has also dropped in price and analysts have rated it as “sell.”

Management is under pressure from shareholders to raise ROE and boost the stock price. The CFO has asked you to attend a meeting at which he intends to develop plans that outline the financial aspects of clear-cutting large sections of the forest. The company will generate additional income from the clear-cut sales and invest some of the surplus money in financial assets to earn a higher return. The goal is to increase the ROE to 11%. He has asked for your input to the financial planning efforts.

Respond to the following questions:

1) What alternatives would you recommend to the CFO based on a NPV and ROE analysis?
2) When you include environmental criteria in the decision, how does this change the decision criteria? Is NPV still relevant? How should the CFO consider social costs?
3) What choices should a company make concerning its natural assets when its ROE is less than that available from instruments available in capital markets? What is the role of environmental management in defining applicable criteria for these decisions?