When seriously considering solar, the first question most people want to know is “Ok, well how long will it take to pay for itself?” From a financial analysis point of view, answering this question is called finding the payback period. At a basic level, this can be very easy to do.
Consider an ideal 12 panel residential roof mounted system that costs $10,000 installed. With a 30% tax credit it now only cost you $7,000 once you receive your tax refund. A system like this could generate about $600 in savings on your electric bill annually. This means after a little more than 11.5 years you will have made back all of your money.
The time value of money and discounted payback period
However, there is much more that can go into a detailed financial analysis of your solar system. If someone asked you whether you would rather have a dollar today, or a dollar in a year, I’m sure you would say you want the dollar today. Maybe, to wait a year for the money you would instead ask for $1.10. What this example illustrates is called the “time value of money,” money received in the future is worth less than money received right now. The same concept applies to investing in solar. It requires investing money now that you can no longer use for other opportunities. For instance, instead of purchasing your solar system you could instead invest in stocks or bonds that may pay you dividends or interest.
To account for the time value of money, it is important to apply a discount rate or required rate of return to the cash flows. This rate can change depending on an individual’s preference for risk and alternative investment opportunities they may have. For instance, perhaps you could instead invest in a treasury bill paying 2.5% interest, or a corporate bond paying 5%. In the case of solar, the future cash flows to consider are the savings on your electric bill. By compounding your discount rate in each successive year, you can develop a present value factors to discount these future cash flows. Adding up the discounted cash flows can give you the value of the investment in today’s terms.
Taking into account the time value of money leads to the discounted payback period method. Using this method, the 12 panel system described above may take 12-15 years to pay for itself depending on what interest rate is selected.
Another major factor to consider is inflation. This is the idea that a loaf of bread that cost $2.50 today will likely cost $2.80 in 5 years. The same effects of inflation that you see at the grocery store also applies to your electric bill. The U.S. Energy Information Agency has reported that national retail electricity rates historically rise about 3% a year (although the rise is somewhat slower in the Midwest than the national average). This means that as retail electricity rates naturally continue to rise, the value of the savings provided by your solar system will also rise. This effect helps to offset the discount effect of the time value of money described above. No one wants higher electricity rates, but in the case of solar, it could help your system pay for itself sooner. Exact future inflation rates could be very hard to predict. Although, in my opinion, it seems likely that retail electricity rates will continue to rise, this may not end up being the case in the future.
The bottom line
At MHK Solar, we will always provide you with detailed financial projections for your investment. We are happy to answer any questions and take into consideration your specific concerns or circumstances. Although future projections are always subject to risk and uncertainty, we want to take the time to provide you with the most accurate and realistic information available so you can make the best decision for yourself.