Internal Rate of Return (IRR) of a Photovoltaic System

If, instead of buying a photovoltaic system, I put the same amount of money into an investment, what return would I have to receive in order to pay for the electricity the PV system would have provided?

The rate of this return is called the Internal Rate of Return or IRR.

When you invest in a photovoltaic system, you receive non-taxable dividends each year in the form of the cash that is no longer being paid to the utility company. The photovoltaic system has an internal rate of return higher than the yield achievable through most other investments (see table 1). In other words, if you put money equal to the net cost of a PV system into an investment, and withdraw the money to pay your utility bills, you have to receive a return equal to the PV IRR on a tax-free investment (or equal to the Taxed Equivalent Rate on a taxable investment) to perform financially as well as investing in a PV system.

Table 1

Electricity Rate Inflation*	PV Internal Rate of Return	Taxed Equivalent Rate**
-2%	5.2%	7.7%
-1%	6.3%	9.2%
0%	7.4%	10.8%
1%	8.4%	12.4%
2%	9.5%	14%
5%	12.7%	18.7%

*the historical average rate of inflation for electricity rates has been 2%. PG&E's "Average Retail Electricity Prices" have averaged 5.15% annual increases from 1980 to 2001, rising from 4.79 cents/kwh in 1980 to 13.06 cents/kwh in 2001 (source: http://www.energy.ca.gov/electricity/weighted_avg_retail_prices.html).
**assuming a marginal tax rate of 32%
Other assumptions:
a. Each peak kilowatt of PV capacity will yield 1443 kwh of electricity per year
(this is a conservative estimate. many sources use a figure of 1750 to 1950 kwh).
b. Electricity produced is displacing Tier V consumption valued at $0.258/kwh.
c. PV system costs $4789 per kilowatt and has a lifetime of 30 years. A federal tax credit is pending which will reduce this, effectively increasng the IRR. Most PV modules are warranteed by their manufacturers for 20 to 25 years.
d. PV system has no value at the end of 30 years. In fact, the PV system may keep operating for many years after that, producing free electricity.

Since savings on utility charges are not taxable, the fair comparison is with an investment's after-tax returns. The rate of a taxed investment which will provide the necessary returns is listed as "Tax Equivalent Rate".

Such calculations show a photovoltaic system to be a pretty good investment. There are some unknowns, such as the future price of electricity, and some variables, such as the homeowner's marginal tax rate and the size and cost of the PV system, but the following examples show some interesting results for two different scenarios. The projection for your house will depend on your consumption patterns and tax status - contact us for a personal analysis by email at tony@appliedsolarenergy.com or by phone at 831-333-1919 x 20.

For example, a home averaging 566 kilowatt-hours per month putting in a 2 kilowatt PV system will get economic benefits equal to an investment paying 9.4%, assuming electrical rates rise at one-half their historical rates and they only get the current 15% tax credit. (See Table 2)

If the home averages 1000 kilowatt-hours per month, the pending Federal tax credit is signed into law and rates rise at their historical 2%, a 2 kilowatt PV system will yield the equivalent of an investment paying 18.4%. (See Table 3) If you use a lot of electricity, even if rates DECLINE at 2% per year, a PV system is as good as a bank account paying 11.9%!

Table 3: Replacing Tier V electricity, with 30% tax credit (California and Federal)

Returns as a function of electricity rate inflation

Electricity Rate Inflation  -2%  -1%  0%  1%  2%  3%  4%  5% PV IRR  8.1%  9.2%  10.3%  11.4%  12.5%  13.6%  14.7%  15.8% Taxed equivalent rate 11.9% 13.5% 15.1% 16.8% 18.4% 20% 21.6% 23.2%

Assumed Values for Variables 32% Marginal Tax Rate 1.98 kilowatt peak capacity System size 2887 kilowatt-hours PV annual production $7559 PV Cost (after CEC rebate, and 30% tax credits) $0.258 per kwh Current electricity rate for replaced power *

* (Tier V, with surcharges)

Sample Calculations