The Financial Pillars Of Solar Project – PAYBACK, NPV, IRR and DSCR

Money tree 3

To determine how much one would make or save over the 25 years’ lifetime of a typical solar project involves a number of factors such as location, sunlight available, technology, incentives, Power Purchase Agreement (PPA) rate, etc.

Evaluating a solar project from a financial feasibility point of view requires understanding a few important measurements which I call the ‘Financial pillars’ as below:

  • Payback
  • Net Present Value (NPV)
  • Internal Rate of Return (IRR)
  • Debt Service Coverage Ratio (DSCR)

HeliCAL Report can help evaluate all of these by providing a detailed financial analysis

Payback

The payback period of a solar project is the time required for the amount invested in the project to be repaid by the income generated through solar energy savings.

This is usually calculated using the formula,

Payback period = Net Solar System Cost/Annual Utility Savings from Solar

The above formula does not account for factors such as depreciation, maintenance costs; etc. hence doesn’t really give the true value of solar over the full lifetime of a solar system. Payback calculated by HeliCAL Report takes into account factors such as maintenance costs, interest on working capital, tax, etc.

Net Present Value (NPV)

The Net Present value takes into account the time value of money and can be used to choose the most lucrative project from a number of projects by comparing their relative profitability. A higher NPV indicates that the project or investment is more profitable.

HeliCAL Report can show you the 25 years lifetime cash flow of your solar project factoring in for interests, O&M expenses, taxes, discount rate and other lost opportunity costs

Internal Rate of Return (IRR)

The Internal rate of return method also takes into account the time value of money. It is used to evaluate the attractiveness of a project or investment or even comparing the returns on two or more investment opportunities.  If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected. (Source: REC-Solar)

Debt Service Coverage Ratio (DSCR)

Debt Service Coverage Ratio is the measure of the cash flow available to pay annual payments, including debt principal, debt interest payments, operations and maintenance, etc. DSCR is especially important for creditors as they look for projects with positive cash flows. For projects in general a DSCR greater than 1 means the project can generate sufficient income to pay its current debt obligations and may be worth investing.

Solar projects have a variable resource which means the actual output of a solar project might be lower than the projected average in any particular year. Therefore solar projects with DSCR in the range 1.2 and 1.5 are usually considered. HeliCAL Report can help determine the DSCR ratio for the debt period.


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