Evaluating Commercial Solar ROI, Payback, IRR and NPV
To help commericialise solar, it is important to underst the financial benefits of installing solar. These can be determined with the following set of financial analysis parameters:
Simple Payback Period
This is known as the length of time it takes for the upfront solar investment to pay for itself through solar energy savings.
The equation is as follows:
Net Solar System Cost/Annual Utility Savings from Solar
In our example, if installation cost amounts to 36 L and we assume you save 7 L per year in utility savings, therefore your payback would be 5 years.
However, this does not account for inflation, depreciation, maintenance costs, project lifetime. Therefore, it doesnt not give the true value of solar over the full lifetime of the project.
Net Present Value
NPV does account for the time value of money.In other words, it factors in inflation, risk, or the lost opportunity of investing in another type of investment, such as stocks and bonds.
This is commonly referred to as the time value of money.
NPV= sum of all the discounted cash flows (PV) over the period of the project.
PV: Present Value
FV: Future Value ( 8.44)
i= discount rate ( 10%)
n= number of periods ( 25 years)
These values give us 7.68, for the first year. Calculate similarly for the remaining years.
Add up all these values to find the NPV.
Return on Investment (ROI)
This is a calculation of how much money will be saved over the entire lifetime of the solar project.
This factor accounts for the following:
- Your current utility kilowatt-hour (kWh) rate and any demand charges.
- Your annual bill without solar.
- The projected annual increase in utility costs over 25 to 30 years based on historical increases.
- The projected amount of solar kWh the system will produce over 25 to 30 years
- The lifetime costs associated with the solar installation, including installation costs, inverter replacement, operations and maintenance cost
- The estimated value of all solar rebates, performance-based incentives, and tax incentives received over 25 to 30 years.
- All applicable taxes.
- All applicable interest/loan costs.In our example, we will take calculate it as:
Total NPV/Intial Project Cost
34.32/36 = 95%
Internal Rate of Return (IRR)
IRR is useful for comparing the returns on two or more investment opportunities. Given the accurate data of each investment, a business can compare the IRR of investing in solar to the IRR of some other capital investment and select the one with the highest return.
In other words, it can also be said that it is the discount rate that causes the NPV to equal zero. That means that the present value of future cash flows equals the value of our investment.
Therefore, higher the IRR, the more attractive the project.