PERFORMING FINANCIAL ANALYSIS
Introduction
When planning an energy efficiency or energy management project, the costs involved
should always be considered. Therefore, as with any other type of investment, energy
management proposals should show the likely return on any capital that is invested.
Consider the case of an energy auditor who advises the senior management of an
organization that capital should be invested in new boiler plant. Inevitably, the
management of the organization would ask:
• How much will the proposal cost?
• How much money will be saved by the proposal?
These are, of course, not unreasonable questions, since within any organization there are
many worthy causes, each of which requires funding and it is the job of senior
management to invest in capital where it is going to obtain the greatest return. In order to
make a decision about any course of action, management needs to be able to appraise all
the costs involved in a project and determine the potential returns. This however, is not
quite as simple as it might first appear. The capital value of plant or equipment usually
decreases with time and it often requires more maintenance as it gets older. If money is
borrowed from a bank to finance a project, then interest will have to be paid on the loan.
Inflation too will influence the value of any future energy savings that might be achieved.
It is therefore important that the cost appraisal process allows for all these factors, with
the aim of determining which investments should be undertaken, and of optimizing the
benefits achieved. To this end a number of accounting and financial appraisals techniques
have been developed which help energy managers and auditors make correct and
objective decisions.
The financial issues associated with capital investment in energy saving projects are
investigated in this chapter. In particular, the discounted cash flow techniques of net
present value and internal rate of return are discussed in detail.
Fixed and Variable Costs
Interest Charges
Discounted Cash Flow Methods
Profitability index
QUESTIONS
1. Cost of a heat exchanger is Rs.1.00 lakhs. Calculate simple pay back period
considering annual saving potential of Rs.60,000/- and annual operating cost of
Rs.15,000/-.
2. What is the main draw back of simple pay back method?
3. Calculate simple pay back period for a boiler that cost Rs.75.00 lakhs to purchase and
Rs.5 lakhs per year on an average to operate and maintain and is expected to save
Rs.30 lakhs.
4. What are the advantages of simple pay back method?
5. What do you understand by the term “present value of money"?
6. Define ROI.
7. What is the objective of carrying out sensitivity analysis?
8. You are investing Rs.100 in a bank. The bank gives 10% interest per year for two
years. What is the present value and what is the future value?
