Author Topic: Calculating the ROI on Solar Panels  (Read 572 times)

iainafro

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Calculating the ROI on Solar Panels
« on: March 13, 2017, 05:11:28 PM »
Hey All,

Personal finance newbie here, but face-punches for being deep in the pool of ignorance welcome.

I'm trying to calculate the ROI on solar panels. The challenge I'm having is with inflation. I don't know how to take it into account.

Here's the calculation:

ROI = (Gain - Cost)/Cost.

Gain is the energy savings for 25 years. (I'm assuming a 25 year solar panel lifetime.)
I've factored in for example, performance decreases on the panels, electricity price rises and the likes. But for simplicities sake:

If the solar panels save $800 a year, every year for 25 years, assuming 3% inflation, I take off 3% every year to the cumulative earnings.

Year 1: 800
Year 2: (Year 1+800)*0.97
Year 3: (Year 2 +800)*0.97
Year 4: (Year 3+800)*0.97
...
Year 25: (Year 24+800)*0.97

My question: Is this the right way to factor in inflation?

It seems to me that by Year 25, I shouldn't be adding in $800, because it will be able to buy a lot less goods, so it should be lower if inflation adjusted. Or maybe I'm overthinking things.

I'd really appreciate any help!
Cheers!
Iain

L.A.S.

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Re: Calculating the ROI on Solar Panels
« Reply #1 on: March 13, 2017, 05:25:21 PM »
It looks like you are trying to do discounted cash flow analysis on your imputed $800 (nominal)/yr savings.  There are lots of calculators online that can help you determine the present value of your future stream of income (or savings).


maizeman

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Re: Calculating the ROI on Solar Panels
« Reply #2 on: March 13, 2017, 05:41:23 PM »
If I understand what you are trying to do, then no, you'd want to do the opposite.

Let's say your electricity bill is $800 this year, but you completely replace it by buying solar panels. If the cost of electricity is inflating at 3% per year, then next year you'd have had an $800*1.03= $824 electrical bill, but you don't, because you already paid for solar panels the previous year.

Now as L.A.S. pointed out there is also the issue of calculating the present value of future income (savings), but that's separate and depends on the rate of return you'd expect from the same money if you didn't spend it on solar panels (so return of a savings account, or bonds, or stock market depending on what you'll do with the money if you don't buy solar panels.)
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Cadman

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Re: Calculating the ROI on Solar Panels
« Reply #3 on: March 13, 2017, 07:19:49 PM »
Maizeman is on the money here. It also depends on how your local utility handles a grid-tie arrangement. Some pay you for any excess generated, some provide a kwh credit to be taken off next month's bill, still others only match 1 for 1 kwh but you gain nothing on excess generated.

Since a good amount of the cost of installing a PV system is in the labor, it can make financial sense to go bigger than you need if your estimates show the PoCo is going to cut you check each month. Some states also offer lucrative payment if you use components made specifically in your state.

Don't forget the Fed tax credit and any state or local credits and rebates that might apply.

iainafro

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Re: Calculating the ROI on Solar Panels
« Reply #4 on: March 14, 2017, 07:41:20 AM »
Thanks a bundle for your replies!

I'm still a little confused. By accounting for inflation, am I right in thinking that this accounts for the present value of future income?

Maizeman, if electricity costs stayed the same at $800/yr, then my savings each year would be $800. But with inflation, my $800 of savings in year 10 wouldn't be worth the $800 in year 1. In year 25, the $800 would be worth a LOT less than in year 1. How would I account for this? (Am I right in thinking that this is accounting for inflation?)

Perhaps my fundamental view of inflation is flawed...

maizeman

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Re: Calculating the ROI on Solar Panels
« Reply #5 on: March 14, 2017, 11:01:59 AM »
Yeah, you are thinking about "present value" not inflation.

With 3% inflation, the electric bill you'd pay in 25 years if you didn't have solar panels would be $1,675 so the savings are higher as you go forward in time.

Edit: So no, you don't use the rate of inflation to correct for the fact that money is less valuable to you the farther into the future you receive it. You should use the, inflation adjusted, rate of return from the alternate investment you'd put your money into if you didn't spend it on solar panels.

Here's an example. Let's say I say I'll pay you $800 in 25 years. You know the long term inflation adjusted CAGR of the stock market is 6.8% so you can calculate that the value of an investment, in real terms, would increase 5.18x over the next 25 years. This in turn means that if you invested $154.44 today, you'd have $800 in 25 years. So the present value of $800 in 25 years in $154.44 today, because if someone else offered you more than that amount of money today in exchange for the $800 I'd be paying you in 25 years, you'd be better off. Inflation rates really don't enter into the equation (except that you need to correct for them in calculating the expected return of your next best investment).

Edit Edit: You don't necessarily want to use the long term growth rate of the stock market, because you could argue the return on investment of solar panels is safer than the stock market. This example was for illustrative purposes only.
« Last Edit: March 14, 2017, 11:15:26 AM by maizeman »
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iainafro

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Re: Calculating the ROI on Solar Panels
« Reply #6 on: March 14, 2017, 01:18:06 PM »
Aren't inflation and present value inherently linked?

For example, if there was 3% inflation, and my bill in 25 years time was $1675, surely my savings would be no higher than the $800 in year 1, because inflation has reduced the purchasing power of the year 25 savings.

Also, you say that inflation doesn't enter into the equation, but you have to use it to get your 6.8% CAGR.... To a layman like me, that doesn't make sense.

Edit: Assuming inflation and electricity price rises were equal, the solar panels would produce the same amount of money year after year. But if inflation is higher, which it historically has been, the surely your savings must decrease?
« Last Edit: March 14, 2017, 01:39:28 PM by iainafro »

VoteCthulu

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Re: Calculating the ROI on Solar Panels
« Reply #7 on: March 15, 2017, 02:31:10 PM »
No, it increases. Say you generate x kW of electricity this year, which is worth $800. If next year inflation makes each kW cost 3% more, then generating x kW again next year will be worth $824 (in next year's dollars).

rg422

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Re: Calculating the ROI on Solar Panels
« Reply #8 on: March 16, 2017, 12:42:05 PM »
You may also have to factor in degradation of the panels themselves.

Ultimately it's a matter of energy usage, geographical location, roof pitch and shading. My brother and I live in the same town in Central California. His house is about half the size of my house and doesn't have a pool (FYI salt water pool require the pump to run longer to produce enough chlorine). His average annual electric bill is roughly $1800 as he's a bit more frugal when it comes to AC use, whereas ours is about $4500. We opted for solar and our break even point is roughly 7 years (12.2kW system designed to produce 110% of our energy use). I don't recall what his break even point for a similarly sized system but it was about 15 years.

Richard
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gimmi80

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Re: Calculating the ROI on Solar Panels
« Reply #9 on: March 16, 2017, 04:26:15 PM »
Have you checked out the Google Solar Roof project website?
It provides some interesting informations.