Check The Payback: Life-Cycle Cost Analysis
Every energy efficiency measure, along with the energy audit itself, should be justified based on the company’s ROI criteria and discount rate for net present value calculations. Conservative energy engineering assumptions and rates should be used to guarantee that the project performs as expected. Top management rarely trusts vendor energy-savings numbers because they tend to favor the vendor’s side of the table to make the project look
It is common to package various energy efficiency measures together to balance steps having a payback of one year or less and ones with longer payback periods. The more attractive efficiency measures help pay for other worthwhile projects with a longer payback period. The key is to focus on major energy savings opportunities and not settle for small capital expenditure projects with attractive ROIs.
The life-cycle cost analysis and net present value calculations provide a better picture of the value of the investment over time. Considering the cost savings over five years, 10 years, 15 years or even 20 years provides a more legitimate assessment of the project’s value over time than a simple payback period method.
Vendors generally include operation and maintenance (O&M) savings as part of the project cost savings. Sometimes this is legitimate, but other times it presents a misleading view of the real cash flow. It is best to acknowledge the O&M savings but not include them in the financial analysis. It may be worthwhile to put together an alternative view of the project with O&M savings taken into consideration but the focus should be on the more conservative financial analysis involving energy savings only.
It is important to recognize the difference between the average value of energy units consumed and saved and the incremental value of those units. While the average cost per kWh might be 12 cents, the real value of the kWh saved could be the incremental value which would be lower, say 10 cents per kWh. The incremental value or cost is the cost of the last kWh purchased or saved from the monthly bill. The cost of the first kWh purchased each month is more expensive than the last kWh purchased. The calculation is specific to an organization’s electricity tariff and where it falls within the tariff. In deregulated markets, the calculation is a little more complicated.
If you can’t calculate the incremental value, another approach is to use the average cost of energy and reduce the projected energy savings by 10 percent to help ensure that the ROI presented to management is conservative and that the project will make its numbers.