We will be considering cash flows - namely, revenues - expenses or savings - costs - in a process called Life Cycle Cost Analysis (LCCA). As you have seen in the reading, cash flows can be developed for systems operations, for investment decisions, and for financing. We will be representing cash flows in a simple, discrete pattern called end-of-period cash flow, where the periodicity is 1 year, and the compounding or discounting uses an annual rate.
Did you see that last bit?
Clients will perceive increased uncertainty and risk without better information available. That's your job! To provide better information and transparent project evaluation, which demonstrates an understanding of both the solar resource and the financials associated with a proposed SECS. Chapter 10 of the textbook discusses how conveying the financial metrics within a project proposal is one way to provide useful information in a transparent manner.
In Life Cycle Cost Analysis, one of the important criteria is the period of analysis, or period of evaluation. The "period" conveys a time horizon for your LCCA. If we recall our microeconomic drivers affecting the elasticity of demand, we know that the time horizon is an important factor. In our case, SECS will tend to have long life-spans.
As such, we are dealing with the concept of "value" at various points in time.
You will notice that the same topics are discussed in detail in the assigned reading of the Manual for Economic Evaluation by Short et al. (1995).
There are two ways to represent discount rates, and you will observe both in the SAM simulation software or similar financial analysis tools. Using these rates, we can produce a discounted cash flow model (DFM) to compare projects.
The Short et al. article shows the Nominal Discount Rate loosely approximated as. But will the fuel inflation rates be the same as labor inflation rates? Or insurance inflation rates? We will have an example in the discussion where we pull apart different inflation rates and use real discount rates in the analysis of a solar hot water system.
We have already seen that the DSIRE website [3] for the states and federal government of the USA is a useful resource for incentives. Part of those incentives are tied in to tax credits, and there is a significant portion of your reading devoted to the concept of depreciation.
One of the things that occurs in an LCCA at the end of the Period of Analysis is the question of how to finish the summation. This is like the Monty Python movie, The Holy Grail [5], where the old fellow says: "I'm not dead!" At the end of your 15-25 year evaluation for LCCA, you will no doubt still have a fully functional SECS! They don't just break down and fall apart, and in fact they will likely last for decades beyond your evaluation period. So how do we assess the value of the system at the end of the period?
We assume that the system has a net salvage value (a resale value) that is a fraction of its initial value, translated into present dollars. In our discussion, we will assume a 20-year-old solar hot water system still has 30% of its initial value, framed in present dollars for year 20.
In this case, if the total system cost is $16,000, its 30% salvage value will be 4,800.
Applying the Present Value formula (see above), with the market discount rate of 8%, we can find:
Salvage value = $4,800 / (1 + 0.08)20 = $1,030
This will be monetary value of the system at the end of its 20-year service life.