Most major energy projects last a long time. A really long time. The median age of a coal-fired power plant in the United States for example, is somewhere around 40 years. Many nuclear power plants have received (or are applying for) license extensions that will effectively permit them to run for 60 years or longer. Even those that aren't quite so long-lived are built with the intention that they will operate for many years. Moreover, different energy technology options have different construction and operating costs (and possibly monetized carbon costs depending on future regulations, but that will be the subject for another lesson). The finances of energy projects can be difficult to evaluate for just this reason - they often involve large immediate capital outlays, followed by a stream of revenues (or costs, if the project is uneconomical) over a long period of time. The process of "discounting" is the way that we think about future costs and revenues in terms of decisions that we are forced to make today.
This lesson will be the most mathematically-intensive of the semester. We will learn about the "net present value" as a way of measuring the benefits versus the costs of a long-lived energy project. We will also discuss several other metrics that can be used to evaluate energy projects, and how these metrics are complementary — and can sometimes cause confusion.
By the end of this lesson, you should be able to:
- determine discounted cash flows for an energy project and calculate the net present value based on the pro forma statements;
- calculate the internal rate of return for an energy project;
- compare the internal rate of return with the project's discount rate, and explain why the internal rate of return will not necessarily lead you to choose the most profitable project;
- calculate the levelized cost of energy for an energy project.
There are lots of good online resources for understanding net present value. Our primary external resource will be the article "Have We Caught Your Interest?" This article goes deeper into the math than we will need to, but is nice and concise, and has all of the relevant information on discounting. You should skim this piece before you start in on the lesson material online. You can then return to the reading as a reference.
What is due for Lesson 9?
This lesson will take us one week to complete. Please refer to the Course Calendar for specific due dates. See specific directions for the assignment below.
- Homework: Submit a word-processed document with the answers to the Lesson 9 questions to the Lesson 09 Drop Box.
If you have any questions, please post them to our Questions about EME 801? discussion forum (not email), located in the Start Here! module. I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.