Economic Analysis
Five metrics, one ranking
Candidates must be fluent in simple payback (capital ÷ annual savings - fast, ignores life and escalation), discounted payback, net present value (NPV, using a present-worth factor on annual cash flows), internal rate of return (IRR, the discount rate at which NPV = 0), and life-cycle cost (LCC, which correctly compares options with unequal lives).
Be precise about conventions. Use real cash flows with a real discount rate or nominal flows with a nominal rate - never mix them. Energy escalation, O&M changes, capital replacement avoidance, and utility rebates all belong in the cash flow, not in the narrative. Compare incremental cost of a higher-efficiency option against the baseline equipment that would be bought anyway. Demand savings must be valued at the actual tariff's demand rate, including ratchets.
Traps. Ranking by simple payback when lives differ dramatically; omitting O&M and maintenance savings; ignoring measure interaction (lighting savings reduce cooling load - count it once); forgetting that escalation raises later-year savings; and using a nominal discount rate against level (real) savings.
Worked example
A $50,000 measure saves 60,000 kWh per year at $0.10/kWh = $6,000/yr. Simple payback = 50,000 ÷ 6,000 = 8.3 years. For a 15-year life at an 8% discount rate, the present worth factor is 8.559, so PV of savings = 6,000 × 8.559 = $51,357 - NPV ≈ +$1,357, essentially break-even. If the owner's hurdle rate is 12%, the factor falls to 6.811 and NPV turns negative at −$9,134: the same measure passes or fails depending on the discount rate, which is why the rate must be stated.