Payback And Return On Investment
Now that we know how much money we’re going to save while still enjoying comparable performance from the lighting system, it is time to do an economic analysis, which includes determining payback and return on investment (ROI). A full-fledged net present value analysis or life-cycle cost analysis is a major undertaking (best to use software), so for our purposes we will determine simple payback and ROI.
Simple payback is the amount of time in decimal years that will go by before a system upgrade option’s energy savings reach the net installation cost (also called the initial cost):
Payback (Years) = Net Installation Cost ($) ÷ Annual Energy Savings ($)
5-Year Cash Flow ($) = 5 Years – Payback (Years) x Annual Energy Savings ($)
Five-year cash flow was chosen based on expectations of the life of the lamps; by factoring in the cost of lamp replacement and other maintenance costs, a 10- or 20-year cash flow can be produced.
Simple return on investment is an internal rate of return, expressed as a percentage, based on the relationship between annual energy savings and the net installation cost:
ROI (%) = [Annual Energy Savings ($) ÷ Net Installation Cost ($)] x 100
Together, they represent a simple and effective first step at determining whether the new equipment would be a good investment for its owner.
In our example, let us suppose that the initial cost of the system (lamps/ballasts only) – – including the cost of the components and labor, waste disposal – – is about $70.00/fixture or $7,000 total (other initial costs may include financing, consulting fees, tax effects and waste disposal).
Simple payback is:
$7,000 ÷ $2,250 = 3.1 Years
Five-year cash flow is:
5 Years – 3.1 x $2,250 = $4,275
($2,250 ÷ $7,000) x 100 = 32%
These results usually must then be compared to the owner’s financial policies regarding capital investment to see if the ROI meets the internal “hurdle rate” and therefore enjoy the best chance of a green light by senior management. It is often desirable to examine a number of upgrade options to make the best choice. Note that some utilities offer programs that reward lower energy consumption with a dollar rebate that can make the upgrade even more attractive.
We will show you how the entire retrofit can be paid for with rebates and from the savings, with no out of pocket investment!