Understanding Solar Returns: IRR
What is the Internal Rate of Return or IRR for solar? In this post, we attempt to simplify IRR by explaining it in layman terms.
Opting for Solar Power is more than just green living; it is an investment as well.
As a solar energy solutions company, we are often asked how investing into Solar can be compared to other traditional forms of easily understood investments, for example: a fixed deposit?
This article is regarding one of the most commonly used metric, called IRR or Internal Rate of Return and how it can be used to evaluate investment into Solar.
What is Internal Rate of Return or IRR?
IRR is used to measure the investment profitability.
In the context of solar, IRR can help you understand the rate of growth that you can expect from your investment in a solar power system. IRR is one of the important parameters which can be used to compare the returns from solar system with another investment, like a fixed deposit (FD).
IRR is the return that you can expect from your investments, setting a benchmark for alternative projects to meet.
The Internal Rate of Return (IRR) is equivalently the discount rate, at which the sum of Net Present Value (NPV) of present investment and all future cashflow (positive or negative) is Zero. It can be thought of as Rate of Growth (of Value) a project is expected to generate during its life, and higher the IRR, stronger are the prospects that the project will generate value for its investor. For a ‘one time deposit’ kind of an investment, the IRR would be equal to the interest rate being offered on the same.
How to interpret IRR for solar?
Let us take an example of a residential society in Pune with 30 kW Solar Installation, who decided to opt Solar Power to reduce their electricity bills.
The solar plant is estimated to generate Net Annual Savings of Rs. 4.65 Lakh, for an initial investment of Rs. 18.1 Lakh for the society. The Internal Rate of Return (IRR) computed for this scenario is 25.6%.
Now imagine same amount being invested in a Fixed Deposit scheme, with rate of interest of 7% per annum, generating interest equivalent of Rs. 1.27 lakh per annum, that too would be taxable.
The returns generated by investing into Solar Power plant are more than 3.5 times that of what is generated in a bank FD, thus indicating that the Society has taken a right decision.
Tool to Calculate IRR for Solar
A solar calculator can help you determine the future profitability of your PV system. It considers factors such as your monthly power bill, electricity consumption and site location to calculate values such as the Internal Rate of Return (IRR).
What can impact the internal rate of return of your solar investment?
Two key factors affecting the internal rate of return of your solar investment are:
- Electricity tariffs: higher tariff means higher savings, thus better IRR
- Performance of solar plant: It is key to select good quality of equipment and workmanship. Also, it is important to ensure timely cleaning of solar panels to ensure sustained performance of the system.
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