Promoting renewable energies - RETS Project

Toolkit and evaluation procedure for
investment decisions
There are several possibilities in the assessment of an
investment, whereas in practice often only the payback
period is considered as a criterion. The payback period,
however, does not indicate an investment’s profitability,
but rather only the time needed to “recover the money”.
The payback period is therefore also only a measure of
risk and not a measure of profitability.
Since in the usual procedure, one and the same payback
period is applied as a standard for all investments (e.g.,
three years), long-term investments — such as
investments in renewable energies or energy efficiency
— are subjected implicitly to higher profitability
requirements.
To avoid this problem, one requires a decision
criterion based on a measure of profitability that
considers the entire usage period of the investment.
The internal rate of return and the present value meet
these requirements. The two quantities are closely
related to one another, as the internal rate of return
ultimately only represents a special case of the present
value calculation.
Example:
With a required payback period of three years, a
production system with a useful life of five years still
“earns” money for two years. However, a combined
heat and power plant with a useful life of 12 years
and the same payback period “earns” money for
nine years and is therefore significantly more
profitable than the production system under the
same conditions. Such excessive implicit
profitability requirements, however, prevent many
investments in energy efficiency or renewable
energies.
Few parameters are generally necessary for calculating
the individual quantities:
Parameter Payback period Internal rate of return Present value
Amount invested incl. all planning and
installation costs
Changed operating costs and reduced
energy costs
X X X
X X X
Calculation interest rate X X
Useful life X X
Payback period (risk):
This is the measure of risk that indicates how long it will
be before the capital is returned or the capital is tied up.
With a required payback period of three years or less,
investments with long useful lives (> 6 years) are
systematically rejected. The remaining useful life is not
considered, even though this is decisive for the
profitability of the investment.
Example investment
Amount to be invested (expenditure):
- €8,000
Costs saved annually2: €2,000
Interest rate: 10%
RETS Compendium – © 2012 RETS Consortium
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