Why Payback Period is a Crude Measure for Solar Panels

For many individuals interested in installing solar panels, question numero uno is: Does it make financial sense to do so? In response to this question, you may hear something like, “the system has a 10-year payback period.” That is, after installation costs, it will take ten years of that system producing electricity before the owner will recoup the initial investment.

While system payback is a fairly intuitive concept — and is therefore widely used in discussions about solar energy cost analysis — it doesn’t provide a full picture of the true costs and benefits of a given solar energy system. Why?

Simply put, typical solar panels reliably produce power for 25 years or more. In the example above, the potential buyer may think 10 years is too long a payback, and opt against installing solar panels. What he’s missing, however, is that after “payback” in year 10, the system would go on to produce electricity for another 10, 15 or 20 years. To see the whole financial picture, these post-payback savings need to be accounted for.

Commonly, this is done by calculating the compound annual rate of return (CARR). In the words of Andy Black, a long-time solar financial consultant, CARR “is another term for interest-rate yield, which is a way of comparing one investment to another. For example, a savings account might pay one percent and the long-term stock market has paid about 10.5 percent. Solar systems in California, New Jersey and a few other locations can often see a pre-tax CARR of 10 percent or more.” It’s true that some solar energy systems will have a long payback period and a low (even negative) CARR. In these instances, solar is probably not the best bet. But it’s also true that some systems offer a decent rate of return even when the payback period is longer than seven or eight years.

I’ll be discussing CARR — along with a related concept, the internal rate of return (IRR) — next week. For the time being, the main take away here is the following. Because “rate of return” accounts for all the utility savings over the entire life of the solar energy system, it provides a more meaningful number with which to discuss the merits of a particular set of solar panels. Take a look at payback period, sure. But don’t stop there. Be sure to consider rate of return when deciding whether solar makes financial sense for you. Solar installers and renewable energy professionals in your area can help.

arriflex Said,

August 20th, 2009 @9:59 am

I appreciate that there is a bigger picture to look at regarding the return on investment; however I also believe it is important to recognize the shortcomings of certain technologies and their eventual impact on the bigger picture…

For example, inverters are unlikely to last anywhere near the 25 year lifespan of the panels. And over the course of the 25 year lifespan of the panels, their output is reduced by some percentage. Many people will be installing on top of roofs that need replacement inside of 25 years.

The basic point is that over that 25 year period there will be costs, a decrease in efficiency, and an increased desire for whatever new technology may be available.

Certainly, while time beyond the “payback” may be considered gravy, caution is prudent if expectations and thereby the reputation of residential solar are at stake.

Adam Said,

August 20th, 2009 @11:44 am

Thanks for your comment, arriflex. Agreed. The above post assumes the variables you mention: module degradation, inverter replacement (usually we assume in year 15) and the possible need to re-roof, which should always be done, if need be, BEFORE putting panels up. Any good solar energy cost analysis/quote should reflect these considerations and include them in the future cash flow picture.

jssmcnet Said,

September 4th, 2009 @12:42 pm

This topic, as I see it, is certainly one of the first obstacles to overcome when discussing solar. I will be volunteering at the solar meeting to help laypeople understand more about solar power from PV. I’m not, however, a finance person so I’m looking for help here. Since you have done some rate of return/financial calculations would you have a calculator program with some variables you could forward me to use in this meeting. I’m looking for payback period with variables that include initial cost, monthly costs, cost of borrowed money (interest rate), depreciation rates (and possibly other tax implications), and on the replacement side, enter the offsetting utilities costs such as electric and gas bills, and possible future increase rate of existing energy. To clarify: if someone came to me saying they have a house with a $200/mn energy bill average this year and the sum of the kWH replacement equivalent would be 2000KWH, how long would it take to payback a solar system that completely or partially replaces the existing if all they could afford was $25000 (assuming this amount could actually 100% replace with incentives)?

Jim jssmcnet@netscape.net

John_in_NC Said,

October 27th, 2009 @1:45 pm

I am not a financial guru either but my PV quote shows a 4% ROI at 20 years. Was hoping better but still going to move on it.

Obviously PV’s are not affected by market fluctuations like my 401K lost but…. I do wonder how global warming will affect my number of sunny days at my location. Seems we have many more clouds and storms which could be devistating for the peformance of PV’s.

My panels will be going up fixed pointing South East.