Author Topic: Should I Include Opportunity Costs When Attempting to Calculate Breakeven Point?  (Read 762 times)

Jadambomb

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Hello.  I am trying to calculate my break-even point on replacing my primary heat source from oil to air-source heat pumps.  Let's assume my assumptions are correct, and I'm assuming I'm going to save about $1500 a year by switching from oil to heat pumps, and my upfront cost of installing the heat pumps is $7,500.  (Keep in mind this $1500 savings includes the increase in my electric bill.).  Obviously, the simplest way to look at break-even point would be to say that it will pay for itself in exactly five years.  However, if you factor opportunity costs into the equation, the break-even point would be much different.  For example, assuming a 7% rate of return on $7,500, that works out to $525 a year, so perhaps I should be subtracting that amount out from my yearly savings and re-run the numbers... i.e. annual REAL savings would be $975).  If I use this number it would take about 7.7 years to break even.  I guess another way to ask the question is this:  Would you say any up front cost that saves less than 7% (of the upfront cost) per year is definitely not worth it because it would never pay for itself?  Is there a savings percentage you might use to say it is worth it if you want a reasonable break-even period?  Like It must be over X?  Say 12% or something (because that really is a 5% savings rate per year)?  Struggling to figure out if it is worth it.

Thank you!

Proud Foot

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In my opinion if you are going to factor in the opportunity cost of the upfront investment then you need to figure out what you are going to do with with the savings.. Using your example of the 7% return invested and investing the $1,500/yr cash savings would get you to 6.36 years to break even. And by year 7 you are making more off your investment than the original $7,500. If you want to get more detailed you can extend the calculation out to the end of the current units estimated useful life.


Honestly the simplest way is to not factor any opportunity cost and do a straight break even. This makes sense to me as it is something that will eventually need replaced and without knowing the estimated remaining useful life brings in too many variables.