Economics, Financing and Project Justification
Core concepts
Candidates must be fluent in simple payback, net present value (NPV), internal rate of return (IRR), savings-to-investment ratio (SIR), and lifecycle cost analysis. Understand discounting: future cash flows are worth less today, so NPV uses a discount rate to bring them back. A positive NPV at the organization's hurdle rate means the project adds value. IRR is the discount rate at which NPV equals zero.
Financing mechanisms
Know the difference between capital budget funding, operating lease, capital lease, energy performance contract (EPC) with shared or guaranteed savings, power purchase agreements (PPAs) for on-site generation, and on-bill financing. Understand that EPCs transfer performance risk to the ESCO and require M&V.
Traps to watch
Questions frequently confuse IRR with the discount rate - IRR is a result, not an input. Another trap is comparing projects with different lives using simple payback alone; use lifecycle cost or annualized cost. Watch for sunk costs being included in incremental analysis (they should not be) and for escalation being ignored in long-horizon analyses. Also remember that SIR compares present value of savings to present value of investment; a value above 1.0 indicates favorable economics.
Worked example
A $100,000 project saves $30,000 per year for five years. Undiscounted cash flow totals $150,000, so simple payback is 3.33 years. At a 10% discount rate, the present value of a five-year $30,000 annuity is $30,000 × 3.791 ≈ $113,700. NPV = $113,700 − $100,000 = $13,700, so the project is justified.
Justification beyond energy
Include non-energy benefits: maintenance savings, productivity, comfort, resilience, and emissions reductions.