Evaluating Solar Energy as an Investment

Installing solar energy in your home or business will yield a stream of tangible and intangible benefits over many years. To help you quantify all the benefits of solar power, Switch to Solar has prepared the below discussion of the typical solar energy system’s costs and benefits.

Financial Benefits Overview

Solar power is an asset that ranks with stocks, bonds, and real estate as something you can invest in with the expectation of earning a return over time.

The most common investment metrics are:

  • Payback
  • Net Present Value (NPV)
  • Internal rate of Return (IRR)
  • Levelized Cost of Energy (LCOE)

All these metrics provide a single number by which you can rank various investment options, and they all focus on evaluating the net cash flows generated by an investment over time.

Net cash flows refers to the stream of financial benefits net of the stream of costs associated with purchasing, maintaining, and disposing of an asset.

In the case of solar power, the financial benefits consist of the cost savings and the various incentives supporting the purchase of the solar energy system. Costs include purchase, installation and maintenance of the system.

Investment Metrics

Payback

Payback is the number of years it takes for the annual net cash flows to equal the initial cost of purchasing the solar energy system. This metric shows how long an asset takes to pay back its upfront cost.

The most important criticism of this metric is that payback ignores the time value of money.

Net Present Value (NPV)

NPV analysis mitigates the key flaw of the payback approach by comparing the stream of net costs and benefits in current value terms. In other words, it discounts each stream back to the present using discount rates that reflect the opportunity cost and risk associated with the cash flows. The NPV of a project is the present value of the benefits minus the present value of the costs.

NPV represents a way of ranking investment alternatives. The larger the NPV, the better the investment. In this way, the NPV, unlike the payback approach, also provides a measure of the amount to be gained (or lost) from the investment.

Internal Rate of Return (IRR)

The IRR approach ranks investment alternatives based on their return – the percentage of the initial investment returned to the investor each year as profit, net of the amount required to simply pay back the investment. The higher the IRR, the better the investment.

Levelized Cost of Energy (LCOE)

LCOE is a cost measure that incorporates the time value of money in a way that’s specific to energy projects.

The primary financial benefit of a solar energy project is the cost savings. You pay for the solar energy system up front, and are “paid back” over time by the “free” energy generated by the system over 25+ years. The LCOE is a way of attributing an implicit price to that energy based on the amount paid for the system upfront and over time.

LCOE is the price for the solar-generated energy that equates or “levelizes” the present value of the project’s benefits and costs. The present values are calculated using the discount rate appropriate to the riskiness of the cash flows. The LCOE can be viewed as the average price of the solar-generated energy over time.

Given that it is specific to energy projects, LCOE is best used in comparing different solar projects to one another and to the LCOE from the grid where grid prices are projected into the future based on a best guess escalator.

Having to calculate an LCOE for grid-supplied energy underscores the point that, when you compare solar to the grid, you are comparing benefits that exist in the future and that you must make some assumptions about the future in order to evaluate the relative merits of the different alternatives.

Evaluating Solar Energy Installation Proposals

As you evaluate different solar energy installation proposals, it’s important to ask for and understand these metrics so you can make an apples-to-apples comparison.

A solar panel installation proposal that offers the lowest total price or the lowest price per kW of capacity may not be the best deal if you end up paying more for the actual solar energy produced. Similarly, you could pay much more for the most efficient system, but not save as much as you expect.

It’s important to pay attention to the assumptions made in the proposals. For example, one proposal may assume that utility prices will rise faster than the other proposal does, or make excessively optimistic predictions about the output generated by the system.

In order to choose the solar energy system that’s right for you, you must examine these assumptions. Be leery of any proposal that doesn’t specify the assumptions that were made.

To Solar 101 > How Solar Pays You Back

Non-Financial Benefits

For many, the decision to install solar power hinges on non-financial benefits, such as:

  • Environmental/climate benefits
  • Health benefits
  • Energy security
  • Support for the grid

These benefits are difficult to quantify in financial terms. However, they do add value to your investment, even if they can’t be incorporated into a formal cost-benefit analysis.

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