Solar Commercialization Case Study 2 35 kWe PV System for a Church Part 1 Steven W. Trimble, PhD Professor of Practice Mechanical and Aerospace Engineering March 2014

2 Agenda 2 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)

3 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

4 Generic Firm Cash Flow Diagram OPERATIONS Net Sales Cost of Goods Sold Interest on Loans Other Expenses Electricity Costs EBTD Depreciation EBT Taxes = τ * EBT After-Tax Income = (1- τ ) EBT Net Cash Flow Increase In Total Equity

5 Time Value of Money 5 "The most powerful force in the universe is compound interest“ - Albert Einstein FV = PV ( 1 + i ) n FV = Future Value PV = Present Value i = interest rate per period n = number of periods

6 Time Value of Money 6 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 ( ) 5 FV = $ 1, $ 1000 $ 1,610.51

7 Time Value of Money 7 Now, suppose you were told that in 5 years you would receive a sum of $ 1, You want to know what that future value is 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

8 Time Value of Money 8 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 i d = 0.02, i.e. PV = $ 1, = $ Mary is a risk taker. She invests only in growth stocks that she expects will earn 15% per year. So her present value is the future value “discounted” by i d = 0.15, i.e. PV = $ 1, = $ ( ) 5 ( ) 5 The discounted present value of a given future value depends on the Discount Rate used.

9 Modeling Inflation 9 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 = $

10 Not All Cash Flows Are the Same 10 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.

11 Using a Spreadsheet 11 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).

12 Net Present Value Analysis Good Project if NPV > 0 based on customer i d NPV = Σ CF i ( 1 + i d ) n i

13 Example NPV Analysis Assume a $10,000 investment is made at the end of Year 0. Cash flows are as follows: Year 1$4000 Year 2 $4000 Year 3-$1000 Year 4$4000 Is this a good project if i d = 10%? 4K 1K 4K 10K

14 Example NPV Analysis For this customer, this is not a good project.

15 Internal Rate of Return What is the discount rate that makes NPV = 0 NPV = 0 = Σ CF i ( 1 + IRR ) n i

16 Example IRR Analysis For the prior example, what minimum discount rate would make the project desirable? This is the customer’s IRR for this project. The Internal Rate of Return (IRR) is 4.5% for this project.

17 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)

18 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)

19 Treasury Grants Section 1603 of the Recovery Act Commercial renewable energy project Cash grant in lieu of 30% ITC Good through December 31, 2011

20 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.

21 DOE Loan Guarantees

22 Accelerated Depreciation Modified Accelerated Cost Recovery System Depreciation (MACRS) Full depreciation over six tax years Bonus Depreciation 100% prior to % starting in 2012 Benefit equal to about 26% of plant cost on a present value basis

23 Generic Firm Cash Flow Diagram OPERATIONS Net Sales Cost of Goods Sold Interest on Loans Other Expenses Electricity Costs EBTD Depreciation EBT Taxes = τ * EBT After-Tax Income = (1- τ ) EBT Net Cash Flow Increase In Total Equity

24 Accelerated Depreciation

25 Renewable Portfolio Standard (RPS) State-level requirement Arizona Corporation Commission makes rules in this state

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28 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

29 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

30 Cash Flow Model for a Homeowner Income Interest on Primary Mortgage Special Tax Credits Taxable Income Taxes After Tax Income Electricity Bill Other Expenses Savings

31 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

32 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

33 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

34 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%

35 Residential Spreadsheet

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37 Residential Spreadsheet IRR = 6.5%

38 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

39 Tempe CCC Solar System Net Metering Solar System Sun SunWest Meter APS Meter Chuch Panel Church Electric Power Loads Grid

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

SunWest System at CCC 41

SunWest System at CCC 42

43 Next Lecture: Part 2 Agenda 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) 44

TVM Problems 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 is 10%? 2. An investment provides two returns. The first is at the end of Year 1 and 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 rate is 5%? Residential Spreadsheet Problem 3. 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 good project for the homeowner?

Depreciation Problem Find: Create Firm Cash Flow Diagram for Second Yr operation of a $50,000 plant Net Sales = $20,000 Costs = $4000 Tax Rate = 35% ITC = 30% Federal Depreciation = Accelerated MACRS No bonus (see table below) MACRS No Bonus Depreciation by Year