Calculating the ROI on Solar Panels

[iainafro]

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

[2Cent]

You don't save money but energy, which also follows inflation. The cost of energy will go up, so the value of your saving will be higher as well. So you should add 3% to your saving instead of reducing.

[SwordGuy]

Are you buying on fixed payments over time?  If so, inflation is working in your favor, not against it.   You'll save energy that costs more due to inflation but your payments will stay the same.   

I really wish that solar panels had been cost effective for us.   But they weren't.  To many trees and the wrong public policy subsidies.   We were ready to plunk down $25,000 for a system but it just wouldn't pay.

[Frizhand]

I agree with 2Cent. I think you're going in the wrong direction. I'm no math wiz but I think you need to multiply by 1.03.

You didn't ask about this but have you looked at all of the other savings that comes with solar panels? local and federal tax credits, SREC programs, etc? They should all be factored into your decision.   I got a large tax credit on my federal taxes and still receive money quarterly from my state's SREC program.  You may also want to talk to a real estate agent to see if the panels will affect the value of your home. 

[Retire-Canada]

Unless you expect electricity to get cheaper to make in absolute terms you can ignore inflation and calculate your ROI in today's dollars.

So if:

- panels cost $15K to install
- you save $800/yr
- you time to ROI = $15K/$800 = 18.75yrs

[SeattleCPA]

I did a blog post this week that might help you with your math. It's about doing ROI calculations for small business investments but you can apply the same logic to your situation. (You need Excel to do the math BTW...) Here's the link:

http://evergreensmallbusiness.com/small-business-investment-returns/

BTW, I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return.

P.S. You can do a pretty reasonable adjustment  to convert a nominal return into a real (adjusted for inflation) return. Just subtract the inflation rate. E.g., if the nominal return is 10% and inflation runs 3%, your real return equals 7%.

P.P.S. I think, when you look at the sort of investment you're considering, if you're really thinking in terms of an investment, that you ought to get a giant ROI. Some multiple of what the stock market delivers.

[2Cent]

I did a blog post this week that might help you with your math. It's about doing ROI calculations for small business investments but you can apply the same logic to your situation. (You need Excel to do the math BTW...) Here's the link:

http://evergreensmallbusiness.com/small-business-investment-returns/

BTW, I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return.

P.S. You can do a pretty reasonable adjustment  to convert a nominal return into a real (adjusted for inflation) return. Just subtract the inflation rate. E.g., if the nominal return is 10% and inflation runs 3%, your real return equals 7%.

No. Because energy is also subject to inflation. So unless your saving will increase along with inflation.

[SeattleCPA]

I did a blog post this week that might help you with your math. It's about doing ROI calculations for small business investments but you can apply the same logic to your situation. (You need Excel to do the math BTW...) Here's the link:

http://evergreensmallbusiness.com/small-business-investment-returns/

BTW, I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return.

P.S. You can do a pretty reasonable adjustment  to convert a nominal return into a real (adjusted for inflation) return. Just subtract the inflation rate. E.g., if the nominal return is 10% and inflation runs 3%, your real return equals 7%.

No. Because energy is also subject to inflation. So unless your saving will increase along with inflation.

I think what you're saying here is that your savings will increase because of inflation.

But unless energy price levels increase at a rate faster than the general price level increases, inflation in energy prices doesn't create extra return.

E.g., if you get $1000 in savings in year 1 and then because of 10% inflation you get $1100 of savings in year 2, you're not coming out ahead in real dollar terms if general price inflation is 10%.

Say, just for sake of illustration, that a person uses that $1000 in savings to pay for family's gasoline for year which cost $1000 in year 1... family can't buy more gallons of gas in year 2 because same amount of gas now costs $1100.

[2Cent]

I did a blog post this week that might help you with your math. It's about doing ROI calculations for small business investments but you can apply the same logic to your situation. (You need Excel to do the math BTW...) Here's the link:

http://evergreensmallbusiness.com/small-business-investment-returns/

BTW, I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return.

P.S. You can do a pretty reasonable adjustment  to convert a nominal return into a real (adjusted for inflation) return. Just subtract the inflation rate. E.g., if the nominal return is 10% and inflation runs 3%, your real return equals 7%.

No. Because energy is also subject to inflation. So unless your saving will increase along with inflation.

I think what you're saying here is that your savings will increase because of inflation.

But unless energy price levels increase at a rate faster than the general price level increases, inflation in energy prices doesn't create extra return.

E.g., if you get $1000 in savings in year 1 and then because of 10% inflation you get $1100 of savings in year 2, you're not coming out ahead in real dollar terms if general price inflation is 10%.

Say, just for sake of illustration, that a person uses that $1000 in savings to pay for family's gasoline for year which cost $1000 in year 1... family can't buy more gallons of gas in year 2 because same amount of gas now costs $1100.

I understand. But when you say "I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return." I think you forget that to get the "regular dollar value" in the future you have to first add inflation. So if you really ignore inflation you would already end up with the real value and have to add inflation to get the nominal value.

[SeattleCPA]

I did a blog post this week that might help you with your math. It's about doing ROI calculations for small business investments but you can apply the same logic to your situation. (You need Excel to do the math BTW...) Here's the link:

http://evergreensmallbusiness.com/small-business-investment-returns/

BTW, I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return.

P.S. You can do a pretty reasonable adjustment  to convert a nominal return into a real (adjusted for inflation) return. Just subtract the inflation rate. E.g., if the nominal return is 10% and inflation runs 3%, your real return equals 7%.

No. Because energy is also subject to inflation. So unless your saving will increase along with inflation.

I think what you're saying here is that your savings will increase because of inflation.

But unless energy price levels increase at a rate faster than the general price level increases, inflation in energy prices doesn't create extra return.

E.g., if you get $1000 in savings in year 1 and then because of 10% inflation you get $1100 of savings in year 2, you're not coming out ahead in real dollar terms if general price inflation is 10%.

Say, just for sake of illustration, that a person uses that $1000 in savings to pay for family's gasoline for year which cost $1000 in year 1... family can't buy more gallons of gas in year 2 because same amount of gas now costs $1100.

I understand. But when you say "I think you ignore inflation...just use regular dollars. And then, when you look at your ROI, recognize that it's a nominal return and not a real return." I think you forget that to get the "regular dollar value" in the future you have to first add inflation. So if you really ignore inflation you would already end up with the real value and have to add inflation to get the nominal value.

Okay, sorry. I think I understand what you're saying. And I think I agree.