Payback of PV? What? Why payback . . . it’s the wrong investment metric!
February 4, 2011 § 1 Comment
In the conversational world of PV economics . . . the issue always is the same. It’s a conditioned response. PV is a great technology, but it costs too much, and the payback is way too long!
What? Whose idea is this, and why has it stuck? Payback is simply the wrong economic measure for evaluating a PV system.
Payback = cost of project / annual cash inflows
Two things we know about PV:
- The total cost of the system is incurred upfront; operating costs are nominal.
- The economic return (electricity generated) is measured over a very long period of time (25 to 40 years).
There are two major problems with using payback as the all-encompassing measure of economic success:
- It is simply a measure of time for the return of initial capital investment. It ignores costs and benefits after the payback period. It is not a measure of system profitability.
- It does not pay attention to the time value of money.
Payback is a risk-weighted relic of oil and gas exploration economic analysis. This oil well will payback in six months! OK, that’s fun to think about, but what if it is a dry hole? A PV system is never a dry hole. Payback is not a measure of investment return. It is simply a time period.
So when asked the question: what is the return on your PV investment? The answer is a discounted (time valued) rate of return of ___% over 25 years. This metric respects initial and ongoing cash investments, operating expenses, income, residual value, tax implications, and the value of money over a finite period of time. This is the measure of economic value.
Quality counts. A user may choose an inexpensive, low quality PV system and save 20% on initial system costs and thereby reduce the payback from 10 years to 7 years. But, a PV system should last 25 to 40 years. If the system has a short payback but produces electricity at a lower rate after 10 or 20 years, the investment return will be low. In this sense, a short payback is a false economy.
Also, when you invest in a PV system (home or business), you become a small-scale independent power producer (IPP). It’s as simple as that. As such, the amount of power you produce over thirty years is most important, not the payback.
When you make a capital investment in a PV system that lowers your operating costs of your home or business, you immediately increase the value of your home or business. How could it be different? If you include this incremental value (15 to 20 times the annual value of the electricity produced) in your payout calculation, the payback will invariably be less than 5 years.
So, payback is not the perfect measure, but if someone insists on asking, feel comfortable saying less than five years and that assumes no increase in utility rates for thirty years.
Is PV economic? Yes it is – from every angle. Just do it!
Chet Boortz, CEO
SES 21 USA