Economic Analysis
What this domain tests
Economic analysis tests whether you can rank measures fairly. Know simple payback, ROI, net present value (NPV), internal rate of return (IRR), and life-cycle cost (LCC), and when each is appropriate.
Core rules
- Simple payback = initial cost ÷ annual savings; it ignores project life and time value.
- NPV = Σ CFt ÷ (1+r)^t − initial cost; accept when NPV > 0.
- IRR is the discount rate where NPV = 0; compare with the hurdle rate.
- Include escalation for energy prices, maintenance, and replacement.
- Count demand savings, tax incentives, and avoided capital as part of the cash flow.
Worked example
A $50,000 retrofit saves $12,000/yr for 15 years. Simple payback = 50,000 ÷ 12,000 = 4.2 years. At an 8% discount rate, the present value annuity factor for 15 years is 8.559. PV of savings = 12,000 × 8.559 = $102,708; NPV = 102,708 − 50,000 = $52,708. Positive NPV confirms the project clears the hurdle, even though simple payback alone says nothing about the 15-year value.
Traps
Using simple payback to reject long-life measures; ignoring energy escalation; double-counting savings; and comparing alternatives with different lives without an annualized or LCC basis.