Unitiiieam 140916060644 Phpapp01

Energy Audit and Management
Prepared by
Prof. Jagdale H.D
Mechanical Engg. Dept.
ICEM
UNIT –III
Energy Economics
CONTENT:
 Financial Analysis Techniques - Simple payback,
Time value of money, Net Present Value (NPV),
Return on Investment (ROI), Internal Rate of
Return (IRR), Risk and Sensitivity analysis.
Costing of Utilities- Determination of cost of

steam, natural gas, compressed air and electricity.
Economics
Is a social science that analyze the production,

distribution and consumption of goods and service
Deals with demand and supply of energy
Financial Analysis
Is an assessment of the viability, stability and
profitability of business, sub-business or any
project
Financial Analysis Techniques
Simple payback period:

Simple Payback Period (SPP) represents, as a first
approximation; the time (number of years) required to
recover the initial investment (First Cost),
considering only the Net Annual Saving
The period of time required for the return on an
investment
Payback period calculated as:
Advantages
A widely used investment criteria

It is simple, both in concept and application.
Obviously a shorter payback generally indicates a
more attractive investment. It does not use complex
calculations.
It favours projects, which generate substantial cash
inflows in earlier years, and discriminates against
projects, which bring substantial cash inflows in later
years but not in earlier years.
Limitations
It fails to consider the time value of money
 Cash inflows, in the payback calculation, are simply
added without suitable discounting
 This violates the most basic principle of financial
analysis, which stipulates that cash flows occurring at
different points of time can be added or subtracted
only after suitable compounding/discounting.
It ignores cash flows beyond the payback period. This
leads to discrimination against projects that generate
substantial cash inflows in later years.
It is a measure of a project's capital recovery, not
profitability
Time Value of Money
A project usually entails an investment for the initial
cost of installation, called the capital cost, and a series
of annual costs and/or cost savings (i.e. operating,
energy, maintenance, etc.) throughout the life of the
project
 Is the value of money in a given amount of
interest earned over given amount of time
 For example, if money can be deposited in the bank
at 10% interest, then a Rs.100 deposit will be worth
Rs.110 in one year's time. Thus the Rs.110 in one
year is a future value equivalent to the Rs.100 present
value
Time Value of Money
The relationship between present and future value is

determined as follows:
Return on Investment (ROI)
 ROI expresses the "annual return" from the project as
a percentage of capital cost.
 considers profit in relation to capital investment.
ROI must always be higher than cost of money

(interest rate); the greater the return on investment
better is the investment.
Net Present Value
The net present value (NPV) of a project is equal to the
sum of the present values of all the cash flows associated
with it.
Symbolically,
Where
NPV = Net Present Value
CFt = Cash flow occurring at the end of year 't' (t=0,1,….n)
n = life of the project k = Discount rate
Calculate NPV, if discount is 10%
The net present value represents the net benefit over
and above the compensation for time and risk.
Hence the decision rule associated with the net
present value criterion is: "Accept the project if the
net present value is positive and reject the project
if the net present value is negative".
Advantages
 It takes into account the time value of money.
 It considers the cash flow stream in its project life.
Internal Rate of Return
The expected rate of return is the interest rate for
which total discounted benefits become just equal to
total discounted costs (i.e. net present benefits or net
annual benefits are equal to zero, or for which the
benefit / cost ratio equals one)
The rate of return is usually calculated by a process of
trial and error, whereby the net cash flow is computed
for various discount rates until its value is reduced to
zero
 The internal rate of return (IRR) of a project is
the discount rate, which makes its net present
value (NPV) equal to zero
The internal rate of return (IRR) can be calculated as:
CFt value will be negative if it is expenditure and

positive if it is savings.
NUMERICALS
Q.1. A sum of Rs. 25000 is deposited in a bank at the
beginning of a year. The bank pays 6.5% interest
annually. How much money will be in the bank account
at the end of sixth year, if no money is withdrawn?
Q.2. Calculate NPV
Annual saving after replacement of a boiler for 4 years is

450000/-, 500000/-, 550000/-,650000/- respectively. The
total project cost is Rs. 1400000 considering cost of
capital as 11.5%
Q.3. Calculate Internal Rate of Return(IRR)
Cash Flows
Two kinds of cash flow; the initial investment as
one or more instalments and the savings arising
from the investment
Capital costs are the costs associated with the design,
planning, installation and commissioning of the
project
Annual cash flows, such as annual savings accruing
from a project, occur each year over the life of the
project; these include taxes, insurance, equipment
leases, energy costs, servicing, maintenance,
operating labour, and so on.
Factors that need to be considered in
calculating annual cash flows
Taxes
Asset depreciation
Intermittent cash flows
Sensitivity and Risk Analysis
Uncertainty in assigning values to the analysis, is
called sensitivity analysis
sensitivity is the project's feasibility to changes in the
input parameters
Sensitivity analysis is an assessment of risk
Factors that are considered for the sensitivity
analysis:
Operating expenses (various expenses items)
Capital structure
Costs of debt, equity
Changing the project duration
Sensitivity and Risk Analysis
Changes in interest rates
Changes in the tax rates
Changes in the accounting standards e.g. methods of
calculating depreciation
Changes in depreciation rates
Extension of various government subsidized projects
e.g. rural electrification
General employment trends e.g. if the government
changes the salary scales
Energy Price change
Technology changes

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Unitiiieam 140916060644 Phpapp01

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Energy Audit and Management

Costing of Utilities- Determination of cost of

Is a social science that analyze the production,

Simple payback period:

A widely used investment criteria

The relationship between present and future value is

ROI must always be higher than cost of money

CFt value will be negative if it is expenditure and

Q.2. Calculate NPV

Annual saving after replacement of a boiler for 4 years is

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