Project Evaluation Methods
Payback
It is common to determine the viability of a project by considering the “payback” period of that project. The payback period is determined by calculating the amount of time required to generate savings equal to the cost of the project.
Simple payback is the most basic calculation, and the easiest to understand. A simple payback is calculated by dividing the total cost of the project by the projected savings per time period. For example, if a project costs $100,000, and will save $50,000 per year, the simple payback is 2 years.
Discounted payback is a more complex calculation, but is generally considered to be more accurate. A discounted payback calculation includes interest costs, taxes, and the time value of money. There is no simple, standardized formula for discounted payback since tax burden, interest rates, and discount rates differ between companies and can vary over time. Discounted paybacks can be calculated via spreadsheet with some very specific information about the project and your company.
Limitations of Payback calculations
Payback periods are often used in financial decision-making due to the fact that a number can be put on the time it will take to recoup the cost of an investment. This is valuable in making go/no-go decisions on a project based. The payback method does not, however, give any information about cash flows after the payback period, and often times does not include the cost of operation of the equipment being purchased.
Life Cycle Costing
Many energy conservation opportunities involve the replacement of an existing system with a new, more efficient system. These systems cost money to procure, install, and operate. While many of these systems have federal or state rebates or other incentives that reduce their first cost, it is still common for the first cost of a premium efficiency system to be slightly higher than a standard efficiency system. When making purchasing decisions on this type of equipment, it is important to understand that the first cost of an energy system may be only a small fraction of the total cost of that system. By purchasing the system, the company is agreeing to pay the energy costs for the system for the next 5 or 10 or even 50 years.
The total cost of the system, including first cost, energy cost, and salvage value, should be considered as part of the procurement process. This is called Life Cycle Costing or whole-life cost.
Example:
A manufacturing company needs a 5 hp motor to power an industrial process. The motor will run continuously (8760 hours per year) at 100% rated load for its useful life of 10 years. A premium efficiency motor is available for $1000, but there is a standard motor that can be purchased for $600. The company owner wants to buy the used motor, thinking that it is saving him $400, but the energy manager knows that the energy costs for this motor will exceed the first cost within the first year of operation. The energy manager has to convince the owner to buy the premium efficiency motor.
The standard motor has an efficiency of 80%. The standard efficiency motor will consume electricity at a rate of 5hp x .746 kW/hp / .80 = 4.66kW. The energy consumed in 10 years will be 4.26kW x 8760hours x 10years = 408,435 kWh. The company pays $.05/kWh of electricity, so this motor will cost $20,422 to operate for 10 years.
The premium efficiency motor has an efficiency of 89.5%. The energy consumption of this motor will be 5hp x .746 kW/hp /.895 = 4.17 kW. The energy consumption will be 4.17kW x 8760 hours x 10 years = 365,081 kWh. At $.05/kWh, this will cost $18,254.
The life cycle costs for the respective motors are $20,422 + $600 = $21,022 for the standard motor and $18,254 + $1000 = $19,254 for the premium motor. Over the life of the project, the premium motor will save $1768 versus the standard motor. The premium motor will actually start saving the company money in the 2nd year of operation.
