Why Payback Sucks as a Way to Value Solar
The most common question I hear when discussing the value of solar is to ask:
"What's the Payback Period?"
Don't answer this question!!
The payback period does have some advantages in that it is a simple thing to calculate and is intuitive. However it is a lousy method for valuing things that have a long useful life, like solar energy. And once the transaction becomes focused on payback period it is hard to get it back to better financial metrics.
Which would you choose:
Returned each year: $4
Payback Period: 3 Years
Useful Life: 5 years
Returned each year: $3
Payback Period: 4 Years
Useful Life: 10 years
If we only use payback period we would choose Option 1. But is that the better choice? Option 1 returns $20 on our $12 investment while Option 2 returns $30 on our $12 investment.
Which is better? Payback period gives us no way to figure it out.
As the useful life increases, payback period becomes an even more distorted lens.
This is why as a Solar Developer you want to stay away from payback period as a discussion. I learned this the hard way. Time after time of marching into a customer's office and presenting the payback period as the first metric we looked at. Then I would spend the rest of the conversation trying to align them back to long term value. The horse is out of the barn already and the lens for viewing the transaction is in place.
There are much better ways to help your customer put a value on a solar system. If you are developing 3rd party ownership projects your investors will value projects in a very different way also.
Next time we will discuss Net Present Value and Internal Rate of Return as approaches that are much more aligned with showing the true value of solar.