Evaluating Commercial Solar ROI, Payback, IRR, and NPV
How much your business saves over the 25 to 30 year lifetime of a typical commercial solar system depends on many factors, including how you finance it, federal and local incentives, your utility rate, and the amount of sunshine available on your commercial rooftop.
Determining the Cost of Commercial Solar Panels
To help commercial and industrial solar customers evaluate the financial benefits of installing solar, REC Solar can provide a free quote and a detailed financial analysis to determine:
- Return on Investment (ROI)
- Net Present Value (NPV), and
- IRR (Internal Rate of Return)
Let’s briefly explore each of these finance evaluation concepts. Some variables will change if financing through a solar lease or solar power purchase agreement (solar PPA).
How is the Solar Panel Payback Period Calculated?
“Simple payback” is the length of time it takes for your upfront solar investment to pay for itself through solar energy savings. To calculate it, most commercial installers take the net cost of the solar system after incentives have been applied and divide it by your projected annual electric bill savings:
Solar Payback Formula
Net Solar System Cost/Annual Utility Savings from Solar = Simple Payback in Years
As an example, if your net commercial installation cost $50,000, and you saved $10,000 per year in utility savings, your payback would be 5 years.
However, simple payback does not account for inflation, depreciation, maintenance costs, project lifetime, and other factors. So it doesn’t really give the true value of solar over the full lifetime of a solar system, and it doesn’t give any rate of return.
REC Solar’s proposals go beyond simple payback formulas and include inflation, depreciation, etc, plus other costs specific to a solar installation. For example, energy bill savings from solar represent a cost not spent, and therefore gives money back to the company, which is then taxed as revenue. REC Solar’s payback definition includes the taxes that may be paid on energy savings.
Solar Panel Return on Investment (ROI) of Solar Panels
ROI gives you another relatively simple perspective of how much money you’ll save over the entire lifetime (typically 25 to 30 years) of a solar project. A comprehensive ROI formula for commercial solar will include:
- Your current utility kilowatt-hour (kWh) rate and any demand charges.
- Your annual bill without solar.
- The projected annual increase of utility costs over 25 to 30 years based on historical increases.
- The projected amount of solar kWh your system will produce over 25 to 30 years
- The lifetime costs associated with the solar installation, including installation costs, inverter replacement, operations and maintenance cost
- The estimated value of all solar rebates, performance based incentives, and tax incentives received over 25 to 30 years.
- Any applicable taxes.
- Any applicable interest/loan costs.
REC’s proposals include ROI values over 10, 20, and 30 years. When all of these negative and positive values are calculated over those time periods, you’ll not only see the payback year, but also the total amount of money saved by going solar.
Net Present Value (NPV)
While ROI takes into account all of the financial benefits and costs of going solar, it doesn’t take into account the future value of the money being invested. That is, it doesn’t factor in inflation, risk, or the lost opportunity of investing in another type of investment, such as stocks and bonds. This is commonly referred to as the time value of money.
NPV does account for the time value of money. Using a solar NPV formula, REC Solar can show you how the 25 to 30 year lifetime cash flow of a solar project compares in today’s dollars, factoring in for inflation, interest, and other lost opportunity costs.
If you’re not familiar with the concept of NPV, the video below explains it in more detail.
In terms of a solar project, the future value (FV) for each year would include all of the upfront costs of installation, plus the projected net annual utility savings and income from any production based incentives, divided by a discount rate.
Over 25 to 30 years, the typical non-residential solar project will show a large and positive NPV.
IRR (Internal Rate of Return)
The Key Differences Between NPV and IRR:
Whereas NPV can show the project’s net present value in dollars, the IRR reveals the rate of return from NPV cash flows received from a solar investment. So, if your IRR is 12%, it means that your solar energy investment is projected to generate a 12% return through the life of the solar system.
IRR is useful for comparing the returns on two or more investment opportunities. Given the accurate data of each investment, a business can compare the IRR of investing in solar to the IRR of some other capital investment and select the one with the highest return.
If you’re not familiar with the concept of IRR and its formula, the video below explains it in more detail:
Calculating the IRR for commercial solar installations depends on many factors, including how you finance it. For a loan, data will include the net cost of the system after upfront rebates and tax incentives, the amount of debt, interest rate on debt, debt term, projected annual cash flow from utility savings, and any pre-tax performance based incentives, as well as O&M costs.
Get a Free Commercial Solar Financial Analysis
Unfortunately we’ve had to be very general with these terms because each solar project can vary widely.
To get more specific information for your potential solar project, we offer a free financial analysis that includes estimated costs, finance options, payback, ROI, NPV, and IRR. Contact us to receive your free solar estimate and financial analysis.