To predict the profitability of an investment, financial calculation methods are used. Since the traditional approach, based on pay-back time, is inefficient, the project propose tools (in web and Excel versions) that enables one to employ several methods, either independently or in combination.
In particular, Net Present Value and Internal Rate of Return prove efficient and helpful for building managers, energy auditors, and other investors.
To use these methods wisely, however, they need appropriate training, and so the tools are accompanied by training material that is both informative and simple to understand.
Interviews with building managers proved that most of them (92%) consider financial calculations critical for justifying energy efficiency measures before making decisions. At the same time, only about half of them find it easy to do—or can even understand financial calculations.
Around 40 interviewed building managers – representing building stock of about 11 million square meters, with over a thousand separate buildings – stated that understandable calculation tools are key to implementing more energy efficiency measures.
The profitability of an energy efficiency investment is crucial, and investment decisions have long-term consequences in the future.
Implementing energy efficiency measures requires comprehensive justification and clear calculations with easy understandable visual charts presented mainly by building managers.
Decision makers and other stakeholders need clear visual information to easily estimate the profitability of various suggested investments. Planning strongly depends on budget restrictions and the availability of convenient funding sources.
All these details are key for decision makers, who have to weigh them to make final decisions. The most common method for financial calculations of energy measures, also in energy audits, is the payback method.
This method does not take aspects of technical lifetime and profitability demand in consideration. Therefore, complementary calculation methods are needed and building managers need knowledge in how to use them.
Building managers need financial calculation tools that are both useful and understandable. If both these requirements are satisfied, a building manager can use them to study the profitability of energy efficiency investments.
EFFECT4buildings have developed two financial calculation tools to evaluate diverse options in a decision-making process in energy efficiency investments. It has also developed relevant training material exists for educational purposes.
Planning a new energy efficiency investment benefits from estimating its life cycle costs. It can be done using cash flow analysis, by predicting all costs and benefits during the investment’s life cycle.
For the investments with long life cycle, it is beneficial to use discounted cash flows, which called Net present value (NPV).
Alternative economic method is Internal rate of return (IRR). Internal rate of return is the discount rate, which makes investments net present value to 0. IRR is the very useful method for decision makers to estimate profitability of investment.
These methods are particularly suitable for choosing different kind of technical solutions for energy efficiency in buildings that may have different initial investment costs, different operating, maintenance and repair costs, and possibly different technical lifetime.
Complementary calculation methods should also be implemented as a standard for energy serving companies, for example, in energy audits.
The Pay back time method
This method works out how long it takes to recover the amount invested (reimbursement period). The advantage of this method is that it is easy to use and understand.
The disadvantage is that it encourages short-term investments because it does not take technical lifetime and interest into account.
The method is not suitable to use for long lifetime investments in the building sector with long life time, for example thermal insulation, window replacements etc.
The net present value method
The method converts all costs and savings to their present value. If the present value of all future savings is greater than the investment, it is considered to be cost-effective.
The net present value method can also be used in comparisons of different options when there are no actual savings to be made.
The present value of the total costs of the different options then shows which is the most cost-effective over a period of time.
The internal rate of return method
The internal rate of return method determines that the present value of the annual savings should be equal to the investment, i.e. the net present value is zero, and calculates what interest rate fulfils that condition. This interest rate is called the internal rate of return.
The internal rate of return method produces a calculated internal rate of return that is equivalent to the annual return on the capital invested. Whether this return is acceptable can be seen immediately by comparing it with the investor’s required rate of return, the cost of capital.
Excel calculation tool
The comprehensive Excel calculation tool proposed in the project is handy, simple and straightforward to use for building managers to study the profitability and other aspects of energy investments.
The tool is accompanied by a comprehensive training material; it describes, among others, all optional methods behind calculations.
The training material can be used as an additional supporting material for studying and sharing information about calculation methods for stakeholders, or as educational material for all possible interested parties.
The financial calculation tool mainly aims to facilitate decision making when implementing energy efficiency investments.
Its charts are easy to use and understand, and so can be employed when presenting financial data to decision makers and other stakeholders.
To help estimate and understand the profitability of an energy efficiency investment, the tool uses the following methods to compare alternative energy efficiency measures:
- Cash flow
- Net present value
- Internal rate of return
- Pay-back time
- Carbon dioxide emissions.
The tool also includes sensitivity analysis, with options to estimate energy and water price changes. In doing so, the tool helps analyse and compare possible future development paths. The calculations can also take into account non-energy benefits.
Simplified web calculation tool
The EFFECT4buildings website presents a web tool for the financial calculations of profitability. Straightforward and simple to use. It helps estimate the rough profitability of individual investments using different calculation methods.
The tool It also visualizes the different calculation methods it includes in pedagogic graphs. Simplified financial calculation tool can be found here: https://energi.jahopp.com/energy.html