Solar Commercialization Case Study 235 kWe PV System for a Church

Part 1

Steven W. Trimble, PhDProfessor of Practice

Mechanical and Aerospace EngineeringMarch 2014

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Agenda

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• Generic Cash Flow Diagram for a Firm• Time Value of Money Review• Modeling Inflation• Net Present Value (NPV)• Internal Rate of Return (IRR)• Solar Subsidies• Depreciation• Residential Case Example• Case Study 2: Tempe Community Christian Church

• Problem Statement• Hypothesized SunWest Analysis• Hypothesized Church’s Analysis

• Homework (now due Monday, April 7)

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Some Financing Questions to Ponder

• How can we compare projects with different cash flows?

• Why is accelerated depreciation desirable for a firm?

• How does society encourage the use of solar energy?

• Why do project owners like to have high degrees of debt?

Note: These are good essay questions for Exam 2

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Generic Firm Cash Flow DiagramOPERATIONSNet Sales

• Cost of Goods Sold• Interest on Loans• Other Expenses• Electricity Costs

EBTD

Depreciation

EBT

Taxes = τ* EBTAfter-Tax Income =

(1-τ) EBT

Net Cash Flow

IncreaseIn Total Equity

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Time Value of Money

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"The most powerful force in the universe is compound interest“ - Albert Einstein

FV = PV ( 1 + i )n

FV = Future ValuePV = Present Valuei = interest rate per periodn = number of periods

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Time Value of Money

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Example: If you invest $1,000 today at an interest rate of 10 percent, how much will it grow to be after 5 years?

FV = PV ( 1 + i )n

FV = $1000 ( 1 + 0.10 )5 FV = $ 1,610.51

1 2 3 4 5

$ 1000

$ 1,610.51

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Time Value of Money

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Now, suppose you were told that in 5 years you would receivea sum of $ 1,610.51. You want to know what that future valueis worth to YOU today.

You know the general form is PV = FV

But, what value of i should be used?

The value of i depends on what interest rate YOU think you can get from the type of investments YOU use.

(1 + i )n

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Time Value of Money

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Tom is very conservative. He invests only in Certificates of Deposit that earn 2% per year. So his present value is the future value “discounted” by id = 0.02, i.e.

PV = $ 1,610.51 = $ 1458.69

Mary is a risk taker. She invests only in growth stocks that she expectswill earn 15% per year. So her present value is the future value “discounted” by id = 0.15, i.e.

PV = $ 1,610.51 = $ 800.71(1 + 0.15 )5

(1 + 0.02 )5

The discounted present value of a given future value depends on the Discount Rate used.

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Modeling Inflation

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• If we know what an expense is at the present time, we can estimate what it will be in the future if we know the expected inflation rate.

• For example, if the cost of a solar unit is $10,000 today, what will it cost two years from now? What inflation rate should we use?

• The selection of the inflation rate depends on many factors. Since the Consumer Price Index has been about 3% for the past few years, let us use that rate for this problem.

• FV = PV (1 + inflation rate)2 = $10,000 (1.03)2 = $

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Not All Cash Flows Are the Same

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• In the prior slide, we can say that the solar system costs

• $10,000 in today’s dollars, i.e., $10,000 (2012 dollars)

Or

• $ in two years, i.e., $ (2014 dollars)

• When talking about cash flows, we must know what year dollars are being used.

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Using a Spreadsheet

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• Problem: A solar system costs $10,000 in today’s dollars. Assume that the system is purchased in 2014 and the inflation rate is 5%/yr.

• Find: Discounted Present Value in 2012 dollars of the solar system cost if the discount rate is 10%. (Assume all cash flows occur at the end of the year).

Description 2012 2013 2014CF in 2012 dollars $10,000Inflation Factor at 5%/yr 1 1.05 1.1025CF in "then year" dollars $11,025Discount Factor at discount rate = 10% 1 1.1 1.21Discounted Present Value $9,112

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Net Present Value Analysis

• Good Project if NPV > 0 based on customer id

• NPV = Σ

CFi

( 1 + id ) n

i

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Example NPV AnalysisAssume a $10,000 investment is made at the end of Year 0.

Cash flows are as follows:Year 1 $4000Year 2 $4000Year 3 -$1000Year 4 $4000 Is this a good project if id = 10%?

4K 4K

1K

4K

10K

1 2 3 4

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Example NPV Analysis

Year 0 1 2 3 4CF in then year k$s -10 4 4 -1 4Discount Factor, id = 10% 1 1.1 1.21 1.33 1.46PV -10 3.6 3.3 -0.8 2.7NPV -10 -6.4 -3.1 -3.8 -1.1

4K 4K

1K

4K

10K

1 2 3 4

4K 4K

1K

4K

10K

1 2 3 4

4K 4K

1K

4K

10K

1 2 3 4

For this customer, this is not a good project.

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Internal Rate of Return

• What is the discount rate that makes NPV = 0

• NPV = 0 =Σ

CFi

( 1 + IRR ) ni

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Example IRR AnalysisFor the prior example, what minimum discount rate would makethe project desirable? This is the customer’s IRR for this project.

IRR 0.045

Year 0 1 2 3 4CF in then year k$s -10 4 4 -1 4Discount Factor 1 1.045 1.092025 1.141166 1.192519PV -10 3.8 3.7 -0.9 3.4NPV -10 -6.2 -2.5 -3.4 0.0

4K 4K

1K

4K

10K

1 2 3 4

4K 4K

1K

4K

10K

1 2 3 4

4K 4K

1K

4K

10K

1 2 3 4

The Internal Rate of Return (IRR) is 4.5% for this project.

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Subsidies: Three Key Types• Federal Tax Benefits

• 30% Investment Tax Credit (ITC)• Accelerated Depreciation

• DOE Loan Program • $10.76 billion in grants through Feb. 21, 2012• Construction must have started by end of 2011

• State Renewable Portfolio Standards (RPS)• Requires utilities to have a % of production in renewables• 29 States and District of Columbia• Solar Renewable Energy Credits (SRECs)• Production Based Incentives (PBIs)

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Investment Tax Credit• Currently 30%, claim during first operating year

• Does not decrease if project subsidized with tax- exempt funding

• On January 1, 2017, reverts back to 10%

• Assets must be retained for a five-year period

• Offset both regular and alternative minimum tax (AMT)

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Treasury Grants• Section 1603 of the Recovery Act

• Commercial renewable energy project

• Cash grant in lieu of 30% ITC

• Good through December 31, 2011

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DOE Loan Guarantees• Section 1705 of Title XVII of Recovery Act authorizes DOE to guarantee loans for certain clean energy projects that commenced construction on or before September 30, 2011.

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DOE Loan Guarantees

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Accelerated Depreciation• Modified Accelerated Cost Recovery System Depreciation (MACRS)

• Full depreciation over six tax years

• Bonus Depreciation• 100% prior to 2012• 50% starting in 2012

• Benefit equal to about 26% of plant cost on a present value basis

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Generic Firm Cash Flow DiagramOPERATIONSNet Sales

• Cost of Goods Sold• Interest on Loans• Other Expenses• Electricity Costs

EBTD

Depreciation

EBT

Taxes = τ* EBTAfter-Tax Income =

(1-τ) EBT

Net Cash Flow

IncreaseIn Total Equity

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Accelerated Depreciation

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Renewable Portfolio Standard (RPS)

• State-level requirement• Arizona Corporation Commission makes rules

in this state

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RPS Results in Incentives by Utilities

• Rebates– Utility pays for part of system

• Solar Renewable Energy Credits (SRECs)– Utility provides payments of varying amounts over

certain years

• Production Based Incentive (PBI)– Utility pays a certain $/kWh incentive for

renewable energy produced

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RPS Results in Incentives by Utilities

• Power Purchase Agreement– Utility agrees to buy energy from producer

according to a fixed schedule– Producer agrees to provide a set amount of

energy versus time– Often it is a fixed purchase price over a long

period such as 20 years– Establishes a predictable revenue stream if the

plant performs—helpful in obtaining financing

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Cash Flow Model for a Homeowner

Income

• Interest on Primary Mortgage

• Special Tax Credits

Taxable Income

• Income Taxes

After Tax Income

• Electricity Bill• Other

Expenses

Savings

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Residential Solar Project• Homeowner Goal: Reduce electric bill cost• Approach: Purchase solar PV system with 20-yr life• Evaluation:

• Net electrical bill savings• Internal Rate of Return

• Revenues:• Investment Tax Credit• SRECs• Electric Bill Savings

• Expenses• Purchase Price of Solar System Installed• Maintenance• Tax on Certain Subsidies

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Example Residential Solar Project Assumptions• System

• Name plate rating = 2 kWe• Cost including installation = $12,000 (2012$s)• Life = 20 yrs• No salvage or disposal costs• Initial annual output = 2000 kWhe• System output degradation = 0.5%/yr

• Maintenance • Annual maintenance = $100 (IOC dollars)• Annual inflation rate = 5%/yr• Inverter replacement frequency = 8 years• Inverter replacement cost = $1400 (then yr $s)

IOC = Initial Operating Condition

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Residential Solar Project Assumptions• Electric Bill Rate

• Cost = $0.20/kWhe (2013 dollars)• Inflation rate = 3%/yr• No salvage or disposal costs• Initial annual output = 2000 kWhe• System output degradation = 0.5%/yr

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Residential Solar Project Assumptions• Subsidies

• Federal ITC = 30%, State ITC = 10% (federally taxable)• RPS induced

• Rebate = $1000• SREC = 5 years: $1000, $995, $990, $985, $980

• Homeowner• Marginal federal tax rate = 25%

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Residential SpreadsheetGiven:

2 0.212,000 3

2000 0.5100 0.5

5 51400 30

8 101000 20,000

0.06475 2517. Federal Tax Rate, %

7. Inverter Life, yrs8. Rebate, $/kWeIRR Discount Rate, fraction

10. Electric Rate Inflation, %/yr11. System Output Degredation, %/yr12. SREC, $/kWhe

16. State Investment Tax Credit Cap, $

13. SREC duration, yrs14. Federal Investment Tax Credit, %15. State Investment Tax Credit, %

1. System Name Plate Rating, kWe2. System Price, $s3. First year annual output, kWhe4. Annual Maintenance, $5. Annual Maintenance Inflation, %/yr6. Inverter Replacement Price, $s

9. Electric Rate, $/kWh

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Year 0 1 2 3 4System Cost,$s -12000Rebate, $ 2000System ITC Basis, $ 10000Fed Tax Credit, $ 3000State Tax Creit, $ 1000Fed Tax on State Credit, $ -250Annual Maintenance, $ -100 -105 -110 -116Inverter Replacement, $Output Degredation Factor 1.000 0.995 0.990 0.985Annual Output, kWhe 2000 1990 1980 1970Incentive (SREC) 1000 995 990 985Electric Rate Inflation Factor 1.000 1.030 1.061 1.093Electric Rate, $/kWh 0.200 0.206 0.212 0.219Electric Bill Savings 400 410 420 431Net Cash Flow -10000 5300 1050 1300 1300Discount Factor 1.00 1.06 1.13 1.21 1.29Present Value -10000 4978 926 1077 1011Cumulative Present Value -10000 -5022 -4096 -3019 -2008NPV -0.397693

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Residential SpreadsheetYear 2012 2013 2014 2015 2016 2017 2018 2019 2020 2032Year 0 1 2 3 4 5 6 7 8 20System Cost,$s -12000Rebate, $ 2000System ITC Basis, $ 10000Fed Tax Credit, $ 3000State Tax Creit, $ 1000Fed Tax on State Credit, $ -250Annual Maintenance, $ -100 -105 -110 -116 -122 -128 -134 -141 -253Inverter Replacement, $ -1400Output Degredation Factor 1.000 0.995 0.990 0.985 0.980 0.975 0.970 0.966 0.909Annual Output, kWhe 2000 1990 1980 1970 1960 1950 1941 1931 1818Incentive (SREC) 1000 995 990 985 980Electric Rate Inflation Factor 1.000 1.030 1.061 1.093 1.126 1.159 1.194 1.230 1.754Electric Rate, $/kWh 0.200 0.206 0.212 0.219 0.225 0.232 0.239 0.246 0.351Electric Bill Savings 400 410 420 431 441 452 463 475 638Net Cash Flow -10000 5300 1050 1300 1300 1300 325 329 -1066 385Discount Factor 1.00 1.06 1.13 1.21 1.29 1.37 1.46 1.55 1.65 3.51Present Value -10000 4978 926 1077 1011 950 223 212 -645 110Cumulative Present Value -10000 -5022 -4096 -3019 -2008 -1058 -835 -623 -1268 0NPV -0.397693

IRR = 6.5%

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Tempe Community Christian Church (CCC) • Church is a non-profit—can’t use tax incentives

• SunWest (third party) --Places solar plant on Church property--Sells all of production to Church at lower than APS rate

• Net Metered—Excess solar production goes through Church meter to grid

• Church takes and gives power to grid as needed

• At end of year, --Net grid power used by Church—Church Pays APS --Net grid power to APS—APS Pays Church

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Tempe CCC Solar SystemNet Metering

Solar System

Sun

SunWestMeter

APSMeter

ChuchPanel

Church ElectricPower Loads

Grid

SunWest System at CCC

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• 35 kWp PV system, two covered-parking structures• Three subsystems, each with its own inverter• Location: 1701 S. College Avenue, Tempe

SunWest System at CCC

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SunWest System at CCC

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Next Lecture: Part 2Agenda

• Hypothetical Analysis for SunWest• Hypothetical Analysis for Church• Actual Contract• APS Bill Analysis• Predicting Outcome of Contract• Analyzing Actual Case Study Data• Lessons Learned

Homework (Now Due April 7)

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TVM Problems

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1. The future value of a two year investment is projected to be $1000.What is the present value of this future cash flow if the discount rate is10%?

2. An investment provides two returns. The first is at the end of Year 1and it is $1000. The second return is $2000 and it occurs at the end of Year 3. What is the present value of this investment if the discount rateis 5%?

Residential Spreadsheet Problem3. Given: A homeowner purchases a solar system at the end of 2012 for$19,000. He/She is eligible for the Federal ITC and the avoided electric costs are $3000 per year in “then year dollars”. The life of the system is five years and there is no salvage value. The homeowner likes to make at least 5% per year on his/her investment. Is this a goodproject for the homeowner?

Depreciation Problem

OPERATIONSNet Sales• Cost of Goods Sold• Interest on Loans• Other Expenses• Electricity Costs

EBTD

Depreciation

EBT

Taxes = τ * EBTAfter-Tax Income =

(1-τ ) EBT

Net Cash Flow

IncreaseIn Total Equity

Find: Create Firm Cash Flow Diagram for Second Yr operation of a $50,000 plantNet Sales = $20,000Costs = $4000Tax Rate = 35%ITC = 30% FederalDepreciation = Accelerated MACRS No bonus (see table below)

MACRS No Bonus Depreciation by Year