Most energy projects involve large capital outlays at the beginning of project life followed by a stream of costs and benefits during the project's years in operation. (Some types of energy projects would end their lives with large capital outlays as well, to handle decommissioning or other environmental issues.) Since waiting to enjoy future benefits from an energy project involves opportunity costs, a dollar of benefit in the future is worth less than a dollar of benefit now. These streams of future costs and benefits need to be expressed in terms of value at the time that the project decision is being considered or initiated. This process is called "discounting."
Project alternatives may have different capital and operating costs even if they ultimately produce the same product. Electricity is probably the best example of this - power plants generally exhibit a tradeoff between capital and operating cost. We developed three different but related metrics to evaluate stand-alone projects and to compare the relative economic merits of project alternatives. The net present value will tell you which project will be the most profitable in absolute present-value dollar terms. The internal rate of return can be useful in comparing percentage returns or "yields" on different projects, or for checking whether a proposed investment exceeds the hurdle rate set by an individual investor or company. The internal rate of return cannot, however, always identify the most profitable project. The levelized cost of energy will tell you the average revenue per unit of output required for a proposed investment to break even, in present value terms. Levelized costs are often compared to prevailing market prices to estimate margins, but this comparison needs to be done with care if energy projects are not expected to run around the clock.
Reminder - Complete all of the Lesson 9 tasks!
You have reached the end of Lesson 9! Double check the What is Due for Lesson 9? list on the first page of this lesson to make sure you have completed all of the activities listed there before you begin Lesson 10. Note: The Lesson 10 material will open Monday after we finish Lesson 9.
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