The Internal rate of return (IRR) is a metrics which calculates the attractiveness, profitability and the feasibility of your project or the solar power system. In this section of Green Energy, I discussed everything
from the role and importance of each component of the solar power system like solar panels, solar charge controller, solar inverter and the solar battery to designing a complete solar power system by yourself. I also discussed the practical ways to reduce the cost and increase the efficiency of your solar power system. It is true that all the above factors play a crucial role in designing an effective solar power system but before going ahead and installing a solar system at your roof top it becomes mandatory to know the financial feasibility of your solar power system and IRR is one of the indicators to know about it. The internal rate of return as I mentioned in the first line of the post estimates the attractiveness of your solar power system. If your project is not attractive enough then it is no use in carrying on the project. So the internal rate of return (IRR) helps you in deciding the financial feasibility of the project.
if the IRR of the project is > the cost of the capital then it is feasible to start the project otherwise not
Before going ahead I think it is better first to understand the concept of cost of the capital.
(1) The concept of cost of the capital
A simple definition:
(2) Know your cost of capital:
Before going to the next step, I think it is important for us to know the calculation of the cost of capital. When you have the money then you can invest the amount and purchase the solar power system by your money (100% equity). Sometimes, you prefer to invest part of your own money and invest the remaining amount using loan (EquityDebt mix). There are times when you take loan for the whole amount and invest that amount in the solar power system (100% Debt). The effective cost of capital in will be different from one case to other.
Let us discuss all this debtequity mix and calculate the effective cost of capital.
Out of the above three cases, the 10% is the highest value of the minimum rate of return and if IRR of the solar power system comes out to be more than 10% then it, automatically fulfills the feasibility criterion of the other two cases that is caseI and the caseII. I am giving the graphical representation of the all the three cases in the chart below: (3) Understand the concept of IRR:
\((\frac{first\ year\ cash flows}{(1 + IRR)^1})\ + \ (\frac{second\ year\ cash flows}{(1 + IRR)^2})\ + \ (\frac{third\ year\ cash flows}{(1 + IRR)^3})\ + ....+.... \ (\frac{nth\ year\ cash flows}{(1 + IRR)^n})\  \ (Initial\ cost\ of\ the\ project)\ = 0\)
(4) Understanding the calculation of IRR:
The cost of the project is my cash outflow and the future cash benefits will be my cash inflows. The IRR discounts my future cash flows by that value of rate of return which make their sum equal to the cost of the project.
Well, before going to the next step of IRR calculation, let us know some of the facts & the assumptions which I have made while arriving at the final value of the Internal rate of return (IRR) and these are as follows:
(5) IRR value when your state provides incentive on purchasing the rooftop solar power system
If your state provides an incentive of 30% on the cost of your solar power system then the IRR of your project comes out to be 16.07% which is around 61% above my cost of capital (10%). It is even higher than the average annual stock market return in India. The table & the chart below shows the future cashflows calculation and the payback period of the system respectively.
(6) The real benefit lies somewhere else
When you are using solar energy over fossil fuels you are actually contributing towards preserving the environment by reducing the carbon content in the atmosphere. The \(CO_2\) emissions have increased from 25,000 Mt in 2003 to 32,000 Mt in 2015. With every unit increase in the \(CO_2\) levels in the environment, increases the threat to our sustainability on this planet. The collective use of the renewable energy sources will help in preserving the environment at the faster rate and this actual benefit surpasses all the financial aspects associated with any project.
(7) What is the point which I want to convey you?
The gist of the whole post is that solar power systems are not only financially feasible options but also a noble way to preserve and save our environment and the planet earth. The IRR is the one of the effective ways to know the feasibility of any project and in this case it is solar power system. I you want to know the feasibility of your solar power system then buy my solar feasibility spreadsheet, an effective way to know the feasibility of your solar roof.
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