We have recently made some small changes in the way that we calculate the lifetime return-on-investment (ROI). Although the changes were minor, there are some situations where they can have a significant impact on the solar proposal.
The calculation for ROI is defined as:
GAINS - COST ---------------- COST
For example, suppose you purchase something for $20 and then sell it for $30. Your ROI is (30 – 20) / 20 = 50%. And that makes sense, you’ve made a profit of $10 on your initial investment of $20, representing a 50% return on your investment.
In order to calculate the ROI for a solar system, we must be sure to consider all of the following factors:
- All payments made by the consumer: up-front cash outlay (in the case of a cash purchase or a down payment for a loan/lease), ongoing monthly payments (in the case of a loan or a lease), and final “balloon” payment, if any (again, in the case of a loan or a lease).
- Electricity cost savings realized as a result of the use of solar panels to generate electricity: this calculation, over the lifetime of the system, should take panel degradation into account, as well as estimated electricity cost inflation.
- SRECs (Solar Renewable Energy Certificates) earned by the consumer based on the solar electricity generated over the lifetime of the system: this calculation should also take panel degradation into account, as well as the terms of the SREC contract that applies (not all states have SRECs).
- Incentives: some incentives are paid up-front, some are in the form of income tax credits (which result in gains during the first year to 18 months after the installation of the system, depending on the installation date), some are in the form of tax deductions (notably, capital depreciation in the case of commercial consumers), and some are in the form of performance-based incentives (PBIs) earned over time during the lifetime of the system (similar to SRECs).
Until recently, we were treating all incentives as cost reductions. A more accurate way to apply the formula would be to treat only the up-front rebates as cost reductions and to treat other incentives (tax credits, tax deductions, and PBIs) as gains.
A homeowner purchases a solar system for cash. The cost of the solar system is $12,000. There is a $2,000 up-front rebate from his state, reducing his actual out-of-pocket cost to $10,000. Because he will be offsetting a significant portion of his electricity usage, he is projected to save an average of approximately $200 per month on his electric bill over the projected 25-year lifespan of his system, for a total electricity cost savings of 200 x 12 x 25 = $60,000. The homeowner is entitled to a $3,000 (i.e., 30%) federal income tax credit when he files his taxes after the system is installed.
Using these figures, his cost is $10,000 — that’s the amount that he must pay the installer (it’s the net out-of-pocket cost for the $12,000 system, minus the up-front rebate of $2,000). His gains include the $60,000 in electricity cost savings plus the $3,000 tax credit. Thus his total gains are 60000 + 3000 = $63,000. And with the formula, his ROI is:
63000 - 10000 ----------------- = 530 % 10000
Based on his initial investment of $10,000 he will earn/save a total of over $60,000 — his “profit” is equal to more than 5 times his initial investment.
But note that using the OLD approach, we would have subtracted the tax credit from the cost. This would yield a cost of 10000 – 3000 = $7,000, and gains of $60,000. And with the formula, his ROI would be:
60000 - 7000 ---------------- = 757% 7000
Note that using the formula the “old” way, the ROI would be reported as a higher value.
Although the “old” way — treating all future incentives as cost reductions — yields a higher (and therefore, more attractive) ROI result, it is not technically correct. And this can be illustrated very clearly by modifying our example scenario very slightly.
Suppose that in our example, the homeowner is also entitled to an additional PBI from his utility, for the first 5 years of operation, based on the electricity that he generates. Suppose this amounts to $1,500 the first year, $1,495 the second year, $1,490 the third year, $1,485 the fourth year, and $1,480 the fifth year, for a total of $7,450.
Using these figures, his cost is still $10,000 — that’s the amount that he must pay the installer (it’s the net out-of-pocket cost for the $12,000 system, minus the up-front rebate of $2,000). His gains now include the $60,000 in electricity cost savings plus the $3,000 tax credit, plus the $7,450 he earns from the PBI (over 5 years). Thus his total gains are 60000 + 3000 + 7450 = $70,450. And with the formula, his ROI is:
70450 - 10000 ----------------- = 604.5% 10000
Based on his initial investment of $10,000 he will earn/save a total of over $70,000 — his “profit” is equal to about 6 times his initial investment. As expected, with the additional PBI that he earns over time, his ROI is higher than it would have been without the PBI.
But note that using the OLD approach, we would have subtracted all of his incentives — including the PBI — from the cost. This would yield a cost of 10000 – 3000 – 7450 = -$450 (a NEGATIVE cost!), and gains of $60,000. And with the formula, his ROI would be:
60000 - (-450) ------------------ = -13433% -450
This clearly demonstrates that it is NOT correct to treat future incentives as a cost reduction; all incentives earned after the initial system purchase should be treated as gains.
That is the change that we implemented.