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Financial Analysis Techniques

The document discusses several financial analysis techniques for evaluating energy efficiency projects: 1) Simple payback period calculates the number of years to recover the initial investment from annual savings, but ignores the time value of money. 2) Return on investment expresses annual return as a percentage of capital cost but does not consider the time value of money or variable cash flows. 3) Net present value calculates the present value of all cash flows and considers the time value of money, favoring projects with positive NPV. 4) Internal rate of return calculates the discount rate that makes the net present value equal to zero, allowing comparison of investment rates of return while considering the full cash flow stream and time value of money

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Bahadur Nazir
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67 views4 pages

Financial Analysis Techniques

The document discusses several financial analysis techniques for evaluating energy efficiency projects: 1) Simple payback period calculates the number of years to recover the initial investment from annual savings, but ignores the time value of money. 2) Return on investment expresses annual return as a percentage of capital cost but does not consider the time value of money or variable cash flows. 3) Net present value calculates the present value of all cash flows and considers the time value of money, favoring projects with positive NPV. 4) Internal rate of return calculates the discount rate that makes the net present value equal to zero, allowing comparison of investment rates of return while considering the full cash flow stream and time value of money

Uploaded by

Bahadur Nazir
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Briefly describe the various financial analysis techniques for investments in energy

efficiency projects and their suitability of application.

Simple Payback Period (SPP) represents, as a first approximation; the time (number of
years) required to recover the initial investment (First Cost), considering only the Net
Annual Saving:

The simple payback period is usually calculated as follows:

First Cost
Simple payback period (SPP) = ---------------------------------
Yearly Benefits – Yearly Costs

(Or) Investment /annual savings

 Simple concept: shorter payback indicate more attractive investment


 Favors project which generate substantial revenues in earlier years
 Fails to consider time value of money
 Ignores cash flow beyond payback period

Return on Investment (ROI) expresses the annual return from the project as % of
capital cost.
This is a broad indicator of the annual return expected from initial capital investment,
expressed as a percentage

 It does not take into account the time value of money

 It does not account for the variable nature of annual net cash flow inflows

The net present value (NPV) of a project is equal to the sum of the present values of all
the cash flows associated with it. Symbolically
 Represents benefit over and above the compensation for time and risk
 Decision associated with NPV criterion is:
 Accept the project if NPV is positive
Reject the project if NPV is negative

 It takes into account time value of money


 It considers the cash flow stream in its project life

The internal rate of return (IRR) of a project is the discount rate, which makes its net present value
(NPV) equal to zero. It is the discount rate in the equation:

 Calculates rate of return that an investment is expected to yield


 IRR expresses each alternative in terms of interest (compound interest rate)
 The expected rate of return is the interest rate for which total discounted benefits become
= zero
 Criteria for selection among alternatives is to choose investment with the highest rate of
return
 It takes into account the time value of money
 It considers the cash flow stream in its entirety
EXAMPLE 1:
80 numbers of fused 60 Watt incandescent light bulbs (ILB) are replaced by same
numbers of 12 Watt CFL instead of new ILB. Calculate the following for 4000 hours of
operation per year.
(i) The annual “kWh saved”
(ii) The “annual kVAh saved” if the power factor of the CFL is 0.6.
(iii) The annual reduction in electricity costs if Rs. 4 per kWh is the energy charge and
Rs. 250 per kVA per month is the demand charge.
(iv) The simple payback period if the ILB costs Rs. 10 and the CFL costs Rs 100
(assume life of ILB and CFL as 1000 hours and 4000 hours respectively)

SOLUTION

(i) The annual kWh saved = 80 x (60 - 12) x 4000/1000


= 15,360 kWh/annum

(ii) The annual kVAh saved if the power factor of the CFL is 0.6.

= 80 x (60 - 12/0.6) x 4000/1000


= 12,800 kVAh

(iii) Annual reduction in energy costs = 15,360 x Rs.4


= Rs. 61,440

Reduction in demand = 80 x (60 - 12/0.6)/1000


= 3.2 kVA
Reduction in demand charges = 3.2 x 250 x12
= Rs.9600
Annual reduction in electricity costs = Rs.61,440 + Rs.9600
= Rs.71,040/annum

(iv) Incremental investment for one CFL for 4000 hrs of operation = 100 – (10 x 4)
= Rs.60
Incremental investment for 80 CFLs for 4000 hrs of operation = Rs.60 x 80
= Rs.4800
Simple payback = 4800/71,040
= 0.068 years or 0.8 month
= less than a month

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