Whenever you consider a major life investment you need to do your homework. Aside from the house and car and the kids college, solar is one of the bigger investments many of us will make. Taking the upfront system cost minus the available incentives divided by the annual energy savings gives us a simple payback in years. For most of our customers in the northwest that number is down under 5 years. Not a bad payback. But what really gets exciting is what happens after you’re system’s paid for.
The Energy Trust of Oregon’s Lizzie Rubado paints the picture really well here:
Escape the simple payback trap
Simple payback is the financial metric customers reference most when considering installing solar or investing in energy-efficiency upgrades, yet it is not the best metric to inform these decisions.
After years of fumbling with the “what’s the simple payback” question, I took some training in financial analysis and accounting and discovered why simple payback is not the most useful metric when discussing investments. While simple payback is a useful second or third screen for determining financing requirements for a project, it is less useful when determining whether a project is profitable. Letting customers consider simple payback alone can prevent them from making investments in solar and efficiency projects that are genuinely profitable.
So why is simple payback a poor metric? The simple payback period tells you the amount of time it takes to recover your initial investment through savings, but it completely ignores the time value of money and any savings generated after the payback period, both of which are financial strengths of a solar investment. Consider a few examples:
- I have two projects for you to consider investing in, both of which cost $20,000 and have a five-year payback. With the first project, you’ll get no cash flow until year five, at which point you’ll get the initial $20,000 investment back. The second project will produce monthly cash flow and, at the end of the fifth year, the sum of the returns will equal your initial $20,000 investment. They both have a 5-year payback, but which project is the better investment?
- What if you had two other projects with 5-year payback periods, but one had a 6-year life and the other had a 15-year life? Which would you choose?
In both cases, the second project is a better investment, but you would never know that if you use only simple payback as your yardstick. We need to start educating customers about better financial metrics such as modified internal rate of return, savings-to-investment (or benefit-cost) ratios and net present value.
This is why it’s so important to get a professional site analysis, system design, shade report and financial calculations done. At Hire we like to make sure you know before you go solar.