Calculating your predicted payback

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First, let’s collect the inputs to our calculation: We’ve already worked these numbers out and scrawled them on the worksheet:

System size you need:_____kW

Your daytime usage: _____

Savings if getting solar hot water: _____

Typical feed-in tariff available in your area: _____c per kWh

Typical usage tariff available in your area: _____c per kWh

Put the numbers above in the online calculator and you’ll see your daily savings and first year’s savings: solarquotes.com.au/simplecalc.

Getting more sophisticated

These simple metrics are good indicators of the value of solar power for you. But they miss out a couple of important things.

Electricity price inflation

Most Australians recently suffered a large hike in electricity prices, and I believe further increases are likely.

Including rising electricity prices in your calculation will make the returns look even better, but this is a double-edged sword. Some salespeople can use big projected price rises to make the payback numbers look unrealistically good, so always ask what their assumptions are when they calculate your returns.

If you think electricity prices will rise then it makes sense to add them to your calculation. I’ve created a calculator that will do all the maths for you, and I’ll show it to you in a minute.

First, let’s talk about cash flow.

Cash flow

Looking at the simple payback, many people make a mistake. They think, ‘Hmm, it will take four years to pay for itself. I can’t afford to lose money for four years; cash is tight. I’ll wait.’

This thinking ignores the cash flow of the savings. Let me explain.

Imagine you’re looking at a $6,000 system that will save you $1,200 a year. That’s a simple payback of five years. Another way to look at it is this: it will save you $100 a month.

If you can finance the system for less than $100 per month, then you’re helping your cash-flow situation immediately. You’ll have more cash in your pocket every month.

Just be aware that if you have tight cash flow every month (join the club!), the monthly savings of solar might be more important to you than the simple payback.

Comparing with savings or other investments

If you’re in the lucky position of having cash to spend, but solar is competing with other investments (such as savings accounts or managed investments), you may want to compare the returns of solar power with the alternatives.

In my opinion, the best way to do this is to calculate the internal rate of return or, even better, the modified internal rate of return. Confused?

The calculator I will show you will provide these metrics. First, I want to explain what they are, and their dangers and uses.

This is not an investment book, so I won’t write a tome on investment metrics and describe how internal rate of return is calculated. If you’re interested, this is a great primer.

Suffice to say that the internal rate of return of an investment gives you an equivalent interest rate for your investment, but – and this is a biggie – it assumes that all your savings are reinvested at the same rate.

Let me explain. Suppose you put the numbers in my calculator. You’re interested in your return over 25 years from a $6,000 solar power system. The calculator pops out an answer of 20% over 25 years. That’s the equivalent of saving a fixed $1,200 every year for those 25 years. (I’m ignoring electricity price inflation to keep things simple.)

Many people hear that they can get an internal rate of return of 20% on a $6,000 investment over 25 years and assume that it’s the equivalent of plonking $6,000 in a term deposit with a 20% interest rate payable over 25 years.

That’s not true. Let’s compare the returns of our imaginary solar system with those of the imaginary term deposit.

A term deposit of $6,000 earning annual compound interest at 20% for 25 years will provide a whopping balance of $572,377.

If you add up all the savings from the solar system ($1,200 x 25 years), and subtract the original $6,000 investment, you only get $24,000 in your bank after 25 years. That’s quite a difference!

What gives?

Well, obviously, the second figure assumes you’re getting zero return on your solar savings.

When comparing investments, we should assume that you invest the returns at a reasonable rate. No bank offers 20% interest.

The way internal rate of return works is that it assumes you invest the savings at the same rate as the internal rate of return. You’d have to find another 20% investment to plough your electricity savings into. Unless you own every house on the street, you’re unlikely to be able to reinvest in solar power, so you’ll be keeping the savings in your bank account. (That’s right, I’m assuming you don’t spend the savings on chocolate.) A much more realistic rate is going to be 3% to 7%.

And this is where the concept of modified internal rate of return comes in. You can modify the internal rate of return by telling it what rate you believe you will be able to reinvest the money at.

My online calculator will find the modified internal rate of return for you. In our example, a $6,000 system returning $1,200 every year for 25 years gives a modified internal rate of return of 10% if we reinvest the savings at 5%.

In my opinion, that’s the number you should use to compare with your compounding investments, such as term deposits.

In our example above, if you buy a $6,000 system, get a fixed saving of $1,200 per year for 25 years and reinvest all the savings in a 5% savings account, that’s the equivalent of depositing the same $6,000 in a fixed-return 10% investment account for 25 years.

Here’s the calculator: solarquotes.com.au/calc.

It will give you much more accurate answers, because it will take into account electricity price inflation, panel degradation and inverter replacement costs. It will also show you cash flow versus savings.

Put your numbers in there and see if the return from your chosen system size will give you a return that you’re happy with.

Then, just for fun, if the system size you’ve chosen doesn’t fill your roof (you can check here: solarquotes.com.au/roof) run the numbers for a system that will. If you get a decent feed-in tariff, I’m guessing that it makes sense to fill your roof with solar panels – if your DNSP and your funds allow it. Bigger is usually better.

Solar has a great payback for most homes, and now you know what it is for yours. You should now have a payback figure, cashflow projections and a figure for lifetime savings if you decide to invest in solar power.

Now I want to go back to batteries.

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