Page 176 - Sustainable Cities and Communities Design Handbook

152 Sustainable Cities and Communities Design Handbook

Financial Analyses
Table 8.2 presents a cost comparison of the City Hall’s annual utility costs with
the City’s proposed 150-kW PV system over an estimated 30-year economic
life, financed over 20 years. The City will enter into a PPA with a developer to
purchase electricity generated by the PV system.
There are multiple methods of financial analysis to consider for a PV
system. The first is the payback period, the length of time required to recover
an initial investment through cash flows generated by the investment. The
payback period is important when considering the City’s financial ability to
implement a PV system.
The internal rate of return (“IRR”) is the discount rate that makes the
project have a zero net present value (“NPV”). Under this method, the project
should be implemented if the IRR is greater than its hurdle rate, i.e., required
rate of return. The NPV is the sum of the present values of the annual cash
flows minus the present value of the investments. The discount rate accounts
for the time value of money and uncertainties present in the NPV. This method
is important as it shows the net value of the PV system from year to year. The
project should be implemented if the NPV is positive.
To explain the strengths and weaknesses of the methods described earlier,
Charles T. Horngren writes (Horngren et al., 2003):
One big advantage of the NPV method is that it expresses computations in
dollars, not in percent. Therefore, we can sum NPVs of individual projects to
calculate NPV of a combination of projects. In contrast, IRRs of individual
projects cannot be added or averaged to represent IRR of a combination of
projects.Two weaknesses of the payback method are that (1) it fails to incor-
porate the time value of money and (2) it does not consider a project’s cash flows
after the payback period.Another problem with the payback method is that
choosing too short a cutoff period for project acceptance may promote the se-
lection of only short-lived projects. [If they use only the pay-back method] An
organization will tend to reject long-run, positive-NPV projects.
The three methods described previously often do not yield the same result.
Table 8.3 displays a financial analysis, based on the above-mentioned methods,
of the proposed solar PV array installation:
Under this example, the payback period is approximately 10 years.
However, the project’s NPV does not become positive until year 11, and
the IRR also does not exceed its required rate of return, i.e., 5% in the
aforementioned scenario, until year 11. By the 30th year, the system is pro-
jected to have experienced $374,846 total paid back and have an NPV of
$111,505.