IRR

Why doesn't SAM include IRR in the economics metrics for the residential and commercial PV models?

Hi Tom,
We assume that the residential and commercial financial models are from a homeowner or business owner's perspective, and that they would not be likely to use IRR to make a decision about whether to install the renewable energy system. They would be more likely to make the decision based on how much it would save on their electricity bill, or based on a payback calculation.
You can estimate the IRR of a given project by running parametric simulations on the real discount rate to find where the NPV goes from negative to positive. For example, these results show that NPV = 0 between a real discount rate of 7% and 8%. At a 2.5% inflation rate, that's equivalent to between 9.7% and 10.7% nominal discount rate, so the IRR would be about 10%.

How are you using the IRR for your analysis? We would be happy to add the metric to the residential and commercial models if there is a useful application for it.
Best regards,

Paul.

We have actually found that a number of businesses generally make their decisions based off of a hurdle rate (minimum IRR acceptable to a particular company). I think it is necessary to have that calculation as part of the results summary for both residential and commercial financial models.

Paul,

Great example of how to use parametric analysis.

In my experience with residential, small commercial, housing projects and municipal facilities payback was always part of the discussion. However, I always encouraged my clientele to think in terms of net present value or cost benefit analysis. The short coming of payback is that it disregards the time value of money. After the break even point there's a cash stream that should still be considered.

Investments in boilers, HVAC systems, motors, envelope improvements are all long term. Just like a PV system. You wouldn't want to disregard an opportunity to reduce operating costs over a number of years because it did not have a short term turn around time.

Clarnd's comment about minimum IRR is real world. However, in my humble opinion it's more applicable to larger commercial or industrial facilities where investing in capital improvement projects are often weighed against one another or process improvements.

Just my thoughts.

Here's another vote to include the IRR calculation in the Residential and Commercial models. I'm spending a lot of time calculating IRR with the parametrics method described here. Thanks.

Paul Gilman wrote: We assume that the residential and commercial financial models are from a homeowner or business owner's perspective, and that they would not be likely to use IRR to make a decision about whether to install the renewable energy system. They would be more likely to make the decision based on how much it would save on their electricity bill, or based on a payback calculation.

Thanks for the IRR workaround, Paul.

Here's another perspective on why I think it makes sense to include the IRR in the simulations: as a homeowner, consumer and stock market investor the IRR is something that I feel I can use to compare this investment to others. I can compare this to the cost of capital, savings account interest rates, or to the annualised returns of the stock market, for example. NPV, on the other hand, is somewhat of a foreign concept, and the payback period in and of itself doesn't tell me much about what happens beyond that point.