Calculating the Internal Rate of Return (IRR) for your PV System

solarroof7 Calculating the Internal Rate of Return (IRR) for your PV System

What is this?  OK, you are considering a serious capital investmentin your home or business; so you should consider a serious investmentmetric to qualify your investment!

The present value rate of return, aka internal rate ofreturn (IRR) is the interest rate at which the net present value ofcosts equals the net present value of benefits.  The IRR metricconsiders the time value of money – that is, the concept that $100 today is worth more to an investor than $100 20 years from now.  This is howsophisticated investors consider the desirability of a capitalinvestments.

An IRR of 0% means that the time value of costs and benefits over the investment horizon are equal or breakeven.  If the IRR is less thanzero, you have lost money.  If the IRR is greater than zero, you havereceived a compounded rate of return on your investment over theinvestment horizon at that interest rate.

Yikes!  How do I do this?  Well, it only takes minutes with a spreadsheet; longer with a financial calculator, or if you must, Google IRR for the formula and take a day of vacation.  Let’s assume the spreadsheet!

Remember, a PV system is a long-term investment, so we are going toreduce all costs and benefits to a single row of annual cash flows thatsum costs and benefits.  In previous writings, we have discussed how to estimate the electricity generated from your PV system and how to convert these kWh’s to a 40 year monetary value stream. 

We know that for a PV system, the capital costs are incurred in yearone.  Maintenance and operating expenses are nominal.  You effectivelyare purchasing 40 years of electricity with an upfront investment. 

There is one exception.  Your PV system includes a component called an inverter.  The inverter is the electronic component that converts the DC current produced by the modules to AC current connected to your electricity panel on the load side ofyour meter.  Most inverters have a warranted life of 15 years.  So, when calculating the costs and benefits, include the cost of a replacementinverter in years 15 and 30.

Create your spreadsheet with a 40 year annual cash flow summingbenefits and costs.  Your capital investment is in the first year, sothat year will have a negative cash flow.  Now, simply select a rate ofreturn function to apply to the data (for Excel, it is IRR), and in less than a second your IRR calculation is complete.

Once the IRR is determined, you can perform sensitivity analysis onyour result by making changes to your system costs and benefits andseeing how those changes impact the IRR.

Congratulations!  It’s your home or business; it’s your PV systeminvestment; and it’s your analysis.  Don’t rely on a canned solution. You know best.

The three most important variables are:

  1. How much electricity will your PV System produce?  (See PV Watts)
  2. How do you value that electricity?
  3. What does your PV system costs? 

Remember; do not sacrifice long-term performance for lesser upfront costs.  Quality counts!  It’s a long-term investment, so strive to maximize your price/performance ratio.

 Chet Boortz, CEO

SES 21 USA

Original Article on SES 21 USA