COLLEGE OF ENGINEERING AND MANAGEMENT PUNNAPRA

MODULE 5
Economic analysis is a crucial tool in evaluating the feasibility and financial viability of
energy projects. By systematically assessing costs, revenues, and potential savings, it
provides decision-makers with the necessary information to make informed investment
choices. In this chapter, we will explore several key methods and techniques used to
conduct an economic analysis, ensuring a comprehensive understanding of how to
assess the economic impact of energy projects.

We begin with the cash flow model, which serves as the foundation for tracking
the inflows and outflows of capital over the life of the project. This model helps to
visualize the timing and magnitude of both costs and revenues, providing a clear picture
of the project's financial performance. Central to economic analysis is the concept of the
time value of money, which reflects the fact that money today is more valuable than
the same amount in the future. Several techniques, including the payback period,
average rate of return (ARR), internal rate of return (IRR), and net present value
(NPV) methods, will be discussed as tools for evaluating the financial viability of
projects.

We will also delve into the life cycle costing approach, a method that
incorporates not only initial investments but also long-term operational and maintenance
costs, ensuring a holistic view of a project's total cost and return over its entire lifespan.
By the end of this chapter, you will have a solid understanding of how to apply these
methods to evaluate energy projects and make sound economic decisions.

1. Cash flow model

In economic analysis of energy projects, cash flow models are used to assess the
financial performance of a project over time. These models track the flow of money into
and out of the project, helping decision-makers understand how the investment will
generate revenues, incur costs, and ultimately produce profits or savings.

​ A cash flow model provides a detailed breakdown of all inflows and outflows of
money throughout the lifecycle of the energy project. It is essential for evaluating the
project's financial feasibility, profitability, and return on investment (ROI).

1.1 Key components of a cash flow model

1.​ Initial investment (capital expenditure - CAPEX): The upfront costs required to
set up the project, including purchasing equipment, installation, permits, and any

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EET424 Energy Management - 2019 Scheme

other initial expenses. This is typically a negative cash flow (an outflow) that
occurs at the start of the project.

2.​ Operational Costs (OPEX): These are the ongoing costs that are incurred during
the life of the project, such as maintenance, insurance, labor, and administration.
These are outflows that occur regularly (e.g., annually or quarterly).

3.​ Revenue or savings (cash inflow): The money coming into the project, either from
selling energy (e.g., electricity from a solar plant) or from savings (e.g., reduced
energy costs due to energy efficiency improvements). These are positive cash
flows and typically occur regularly (e.g., annually).

4.​ Depreciation: A non-cash expense representing the reduction in the value of

assets (e.g., equipment) over time. While depreciation does not directly affect
cash flows, it affects taxes, as it reduces taxable income, leading to tax savings
(i.e., a tax shield).

5.​ Loan repayment (if applicable): If the project is financed through debt, the loan
repayments (principal and interest) are outflows.

6.​ Resale value or salvage value: At the end of the project's life, there may be a
residual value from the sale of equipment, land, or other assets. This is usually a
positive cash inflow at the end of the project.

7.​ Inflation: Over the life of the project, revenues and costs may change due to
inflation or price increases in inputs (e.g., energy prices, labor costs, etc.).
Inflation is often incorporated into cash flow models by escalating revenues
and/or costs at a certain percentage per year.

1.2 Cash flow diagram

A cash flow diagram is a visual representation used in financial analysis to show the
inflows and outflows of cash over time for a specific project or investment. It is a simple
yet powerful tool that helps to illustrate the timing and magnitude of cash flows (money
coming in or going out) in a clear, chronological format.

1.2.1 Key features of a cash flow diagram

●​ Time on the Horizontal Axis: The x-axis represents time, typically in years,
months, or periods (depending on the project's duration).

●​ Cash Flow Amount on the Vertical Axis: The y-axis shows the amount of cash
flow, with positive values (inflows) typically represented above the axis and
negative values (outflows) below the axis.
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●​ Inflow and Outflow Arrows: Arrows or bars are used to represent the amount
and direction of cash flows:
○​ Inflow: Positive cash flows (e.g., revenues, savings, or receipts) are
depicted as arrows pointing upward.
○​ Outflow: Negative cash flows (e.g., investments, operational costs, or
payments) are shown as arrows pointing downward.

Figure 5.1: A typical cash flow diagram

2. Time Value of Money

The Time Value of Money (TVM) is a fundamental financial concept stating that money
available today is worth more than the same amount in the future due to its earning
potential. This principle is based on factors such as investment opportunities, inflation,
and risk. This concept is crucial in financial decision-making, investment analysis, and
project evaluations, including those in energy economics.

2.1 Key components of time value of money

●​ Present value (𝑃𝑉): The present value is the current value of a future amount of
money, discounted at a specific interest rate.

●​ Future value (𝐹𝑉): The future value is the amount of money that an investment
made today will grow to at a specific interest rate over a certain period of time.

●​ Discount rate (𝑖): The discount rate is the rate at which future cash flows are
"discounted" to determine their present value. It reflects the opportunity cost of
capital, or how much return could be earned on an alternative investment. The
higher the discount rate, the lower the present value of future cash flows.
𝑛
𝐹𝑉 = 𝑃𝑉× (1 + 𝑖)

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EET424 Energy Management - 2019 Scheme

Example: Suppose you will receive ₹1,000 in 5 years from now, and the annual
discount rate is 6%. To calculate how much that ₹1,000 is worth today, we use the
present value formula:
1000
𝑃𝑉 = 5 = ₹747. 26
(1+0.06)

3. Simple payback period

The Simple Payback Period (SPP) is a straightforward financial metric used to
evaluate the time it takes for an investment in an energy project (or any project) to pay
back its initial costs through the savings or cash flows it generates. In the context of
energy projects, this usually means the time it takes for the energy savings or revenues
to cover the upfront capital costs of the project.
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝑆𝑃𝑃 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠
Here the initial investment is the total upfront cost of the project (e.g., equipment,
installation, etc.) and the annual savings is the amount of money saved annually (such
as energy cost savings) or the net annual cash inflow generated by the project.

Example: A cogeneration system installation is expected to reduce a company’s annual

energy bill by ₹23 lakhs. If the capital cost of the new cogeneration installation is ₹90
lakhs, and the annual maintenance and operating costs are ₹5 lakhs, what will be the
expected payback period for the project?
90
​ 𝑆𝑃𝑃 = 23−5
= 5 years

3.1 Advantages of SPP

●​ It is simple, both in concept and application. Obviously a shorter payback
generally indicates a more attractive investment. It does not use tedious
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.

3.2 Limitations of SPP

●​ Ignores the Time Value of Money: Does not account for the fact that money
today is worth more than money in the future.

●​ Ignores Post-Payback Cash Flows: Does not consider benefits or savings that
occur after the payback period, potentially undervaluing long-term projects
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●​ Not a Measure of Profitability: Only indicates capital recovery, not overall

profitability or return on investment

4. Average Rate of Return

The Average Rate of Return (ARR) method is a financial appraisal tool used in energy
economics and other fields to evaluate the profitability of an investment or project. It
measures the average annual return (profit) generated by an investment as a
percentage of its initial or average cost. This method is widely used for comparing
projects and making investment decisions.
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡
𝐴𝑅𝑅 = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑜𝑟 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
× 100

Example: Suppose a company invests ₹4,00,000 in an energy-saving project expected

to generate annual returns of ₹1,00,000 in year 1, ₹2,00,000 in year 2, ₹1,80,000 in
year 3, ₹1,20,000 in year 4, and ₹1,00,000 in year 5.
​ Total cash in-flow = ₹7,00,000
700000
​ Average annual profit = 5
= ₹140000
140000
ARR = 400000
× 100 = 35%

4.1 Advantages of ARR

●​ ARR is easy to calculate and understand
●​ It allows comparison between multiple projects to identify the most profitable
option
●​ It emphasizes annual returns, which are critical for businesses focused on short-
to medium-term gains

4.2 Limitations of ARR

●​ Ignores Time Value of Money: ARR does not account for the time value of
money, unlike methods such as Net Present Value (NPV) or Internal Rate of
Return (IRR).
●​ Risk Oversight: It does not directly account for risks or uncertainties associated
with future cash flows.

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EET424 Energy Management - 2019 Scheme

5. Net Present Value

The Net Present Value (NPV) method is a financial analysis tool used to evaluate the
profitability of an investment or project by calculating the present value of all future cash
flows over a project’s lifetime. The NPV is calculated using the following formula.
𝑛 𝐶𝐹𝑡
𝑁𝑃𝑉 = ∑ 𝑡
𝑡=0 (1+𝑟)
Here 𝐶𝐹𝑡 is the net cash flow during year 𝑡, 𝑟 is the discount rate (e.g., cost of
capital or required return) and 𝑛 is the project’s lifetime in years.

5.1 Interpreting NPV

​ NPV > 0: The project is expected to generate more cash than what is needed to
recover the initial investment and provide the required rate of return. It’s considered a
good investment.

​ NPV = 0: The project is expected to break even, generating exactly enough cash
to cover the investment and provide the required return. It’s typically considered a
neutral or marginal investment.

​ NPV < 0: The project is expected to generate less cash than required, meaning it
would destroy value and is typically considered a poor investment.

Example: A project requires a ₹1,00,000 initial investment and generates ₹30,000

annually for 4 years at a 10% discount rate.
−100000 30000 30000 30000 30000
𝑁𝑃𝑉 = 0 + 1 + 2 + 3 + 4 =− ₹4904
1.1 1.1 1.1 1.1 1.1
Since the NPV is negative the project is not viable.

5.2 Advantages of NPV

●​ Accounts for Time Value of Money: NPV explicitly adjusts for the fact that
future cash flows are worth less than current cash flows.

●​ Clear Decision Rule: If NPV > 0, accept the project; if NPV < 0, reject it. This
makes it straightforward for decision-making.

●​ Comprehensive approach: NPV takes into account all cash flows over the life
of the project, providing a complete financial picture.

●​ Risk-adjusted analysis: By using an appropriate discount rate (e.g., based on

the project’s risk), NPV can reflect the project’s riskiness.
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5.3 Disadvantages of NPV

●​ Depends on Accurate Cash Flow Estimates: The accuracy of NPV relies
heavily on correctly predicting future cash flows, which can be difficult to
estimate, especially for long-term projects.

●​ Choosing the Discount Rate: Selecting the appropriate discount rate can be
challenging, and small changes in this rate can significantly affect the NPV
calculation.

●​ Complex for Non-Standard Cash Flows: For projects with irregular or

non-standard cash flow patterns, calculating NPV can become more complex
and less intuitive.

6. Internal Rate of Return

The Internal Rate of Return (IRR) is a key financial metric used to evaluate the
profitability of an investment or project. It represents the discount rate at which the NPV
of all future cash flows (both inflows and outflows) equals zero. In other words, the IRR
is the rate of return at which an investment breaks even in terms of the present value of
cash flows. Mathematically, IRR is the discount rate 𝑟 that satisfies the following
equation:
𝑛 𝐶𝐹𝑡
𝑁𝑃𝑉 = ∑ 𝑡 = 0
𝑡=0 (1+𝑟)

If the IRR of a project or investment exceeds the required rate of return (also
called the hurdle rate or cost of capital), the project is considered financially attractive. If
the IRR is lower than the hurdle rate, the project is typically rejected.

6.1 Advantages of IRR

●​ Intuitive and Easy to Understand: IRR is expressed as a percentage, which
makes it intuitive and easy to understand for most people, regardless of their
financial background. The higher the IRR, the more profitable the investment
appears to be. It provides a direct way to compare the profitability of different
projects. You can simply compare the IRR of different projects to decide which
one offers the highest return.

●​ Accounts for time value of money: Unlike simple metrics like payback period, IRR
takes into account the time value of money. This means that it reflects the fact
that money received in the future is less valuable than the same amount of
money received today. This makes IRR a more accurate measure of long-term
profitability compared to non-discounted methods.

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EET424 Energy Management - 2019 Scheme

●​ Decision making is simplified: The decision-making process with IRR is simple.

You compare the IRR to your required rate of return (also called the hurdle rate
or cost of capital) and If IRR is greater than the required rate of return, the project
is considered viable and should be accepted, else the project is rejected.

●​ Independent of Project Scale (Relative Return): IRR provides a relative

measure of profitability that is independent of the scale of the investment. This
is useful when comparing projects that may have different initial investments but
similar growth or return rates. It helps to highlight which project has the highest
rate of return per unit of investment.

6.2 Limitations of IRR

●​ IRR can favor short-term projects with high returns over longer-term projects that
may have steady but lower returns. This can lead to rejecting projects that add
more value over time simply because their IRR is lower.

●​ IRR assumes that cash inflows can be reinvested at the IRR itself, which is often
unrealistic. In practice, reinvestment rates are often lower than the IRR,
especially in long-term projects.

●​ IRR calculation requires iterative methods or software tools, as it cannot be

solved algebraically in most cases. This can complicate analysis, especially for
projects with irregular cash flows.

7. Life Cycle Costing Approach

Life Cycle Costing (LCC) is a systematic approach for evaluating the total cost of
ownership over the life of an energy project, taking into account all stages - from
planning and development to operation and decommissioning. It provides a
comprehensive way of assessing the financial viability of energy projects by considering
both upfront and ongoing costs, as well as potential future costs. This approach is
particularly useful in energy economics because energy projects often have long life
spans and substantial future costs.

Here’s a breakdown of the steps involved in using the Life Cycle Costing
approach for the selection of energy projects:

1.​ Define the project scope and objectives

○​ Scope: Specify the project’s boundaries (e.g., solar farm, energy-efficient
HVAC system) and its expected lifespan (e.g., 20years)
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○​ Objectives: Clarify goals such as minimizing total ownership costs,

comparing alternative technologies, or meeting sustainability targets.

2.​ Identify life cycle stages: A typical energy project goes through several stages
during its life cycle, and each stage incurs costs. The main life cycle stages are:
○​ Planning and Design: Includes feasibility studies, permitting,
environmental assessments, and initial engineering design.
○​ Construction and Installation: The cost of building the energy facility,
including the purchase of equipment, labor, materials, and any
infrastructure development (e.g., grid connection).
○​ Operation and Maintenance (O&M): Ongoing costs for the operation of
the energy facility, including fuel costs (for non-renewable projects), staff
salaries, routine maintenance, repairs, and administrative costs.
○​ Decommissioning and Disposal: The costs associated with dismantling
the energy facility, safely disposing of waste, and restoring the site (if
necessary) at the end of its life.

3.​ Estimate and collect cost data for each life cycle stage: Once the stages are
identified, gather detailed data on costs associated with each stage. This data
can be broken down into several categories:
○​ Initial Costs (capital expenditures or CAPEX): This includes costs like
construction, equipment procurement, land acquisition, permits, etc.
○​ Operational Costs (OPEX): This includes ongoing expenses such as
energy production costs (fuel, if applicable), maintenance, labor,
insurance, and utility fees.
○​ End-of-Life Costs (decommissioning and disposal): Includes the costs for
decommissioning the facility and handling any waste or environmental
concerns.

4.​ Adjust for time value of money: Convert future expenses (e.g., maintenance,
energy savings) to present value using a discount rate.

5.​ Calculate the total life cycle costs: The total life cycle cost (LCC) of a project is
the sum of all the discounted costs across each stage.

LCC = Initial costs + Operating costs + End-of-life costs - Revenue

6.​ Evaluate alternative technologies or project designs: Use metrics like Net
Present Value (NPV), Internal Rate of Return (IRR), or Discounted Payback
Period (DPP) to rank projects. This step helps in identifying the most
cost-effective option, considering the specific project conditions (e.g., location,
resource availability).

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EET424 Energy Management - 2019 Scheme

7.​ Assess non-monetary factors: Although Life Cycle Costing is primarily focused
on financial factors, it’s important to assess non-monetary benefits and costs as
well. For energy projects, these can include,
○​ Environmental impact: Carbon emissions, resource depletion
○​ Social and regulatory risks: Compliance with energy efficiency
standards or community impacts

8.​ Make the decision: After collecting all the data, performing the necessary
analyses, and considering both financial and non-financial factors, make an
informed decision about which energy project to select. This decision should be
based on the lowest life cycle cost, balanced against the project's potential
benefits (e.g., energy security, emissions reductions, social impacts).

8. Computer Aided Energy Management Systems

Computer-Aided Energy Management Systems (CAEMS) are sophisticated tools that
integrate hardware and software to monitor, control, and optimize energy flows within
various systems, ranging from small buildings to large utility grids. These systems
leverage advanced digital technologies, real-time data, and automation to improve
energy efficiency, reduce costs, and support sustainable energy practices.

8.1 Key components and functions of CAEMS

●​ Hardware Components: Include data collection devices like gateways and
sensors that gather real-time information on energy generation, consumption,
and storage. These devices operate independently of manufacturers to ensure
compatibility and flexibility.

●​ Software Components: Utilize algorithms and control rules to analyze data,

make decisions, and optimize energy usage. The software processes inputs such
as rooftop solar production, battery status, load demands, weather forecasts, and
electricity prices to determine optimal actions like charging/discharging batteries
or shifting loads.

●​ User Interface: Provides visualization tools for operators and users to view live
and historical data, set parameters, and manage energy flows. This interface
enables easy monitoring and control of energy assets.
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8.2 Benefits of CAEMS

1.​ Energy Efficiency Improvement
●​ By monitoring real-time energy consumption and identifying inefficiencies,
CAEMS help reduce unnecessary energy use. This can lead to a
significant reduction in energy costs and operational expenses.
●​ Automated control of energy-consuming devices (e.g., lights, HVAC
systems) based on occupancy or weather data ensures that energy is only
used when needed, thereby improving efficiency.

2.​ Cost Savings

●​ Reduction in Energy Bills: By optimizing energy use and reducing
wastage, CAEMS help organizations lower their utility bills.
●​ Peak Demand Management: CAEMS can manage peak demand times
(when energy prices are high) by shifting energy use to off-peak hours,
resulting in lower energy costs.

3.​ Environmental Impact Reduction

●​ CAEMS contribute to reducing a building’s or organization’s carbon
footprint by minimizing energy waste and promoting the use of renewable
energy sources. This is particularly important for organizations striving to
meet sustainability goals or reduce their greenhouse gas emissions.

4.​ Real-Time Monitoring and Control

●​ Real-time energy monitoring allows users to detect and respond to any
issues promptly. This reduces downtime and ensures that
energy-consuming equipment is always operating at its most efficient
capacity.
●​ Immediate feedback on energy consumption patterns also empowers
users to make informed decisions on improving energy management.

5.​ Regulatory Compliance

●​ Many countries and regions have energy efficiency regulations or
sustainability requirements. CAEMS can help organizations comply with
these standards by tracking energy use and emissions and providing the
necessary reports for compliance.

6.​ Enhanced Decision-Making

●​ By using the data collected by CAEMS, organizations can make better
decisions about energy procurement, equipment upgrades, and efficiency
projects.

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EET424 Energy Management - 2019 Scheme

●​ Scenario simulations allow decision-makers to test different energy

management strategies before implementing them, reducing risks and
improving outcomes.

9. PYQs and Solutions - Numericals

Q1. EE482 May 2019 (2015 scheme)
A solar power plant uses twelve mercury vapour lamps of 200W for lighting during night.
It was found that a high pressure sodium vapour lamp of 150W produces the same
lumens compared to the mercury vapour lamp and the ballasts were matching. If the
lamps are working for 10 hours a day, compute the simple payback period. Cost of
electricity is ₹5/kWh and the cost of one 150W high pressure sodium vapour lamp is
₹1600.
Solution:
Power reduction achieved by = 12 × (200 − 150)
replacing 12 mercury vapour = 600
lamps with sodium vapour
lamps (W)

Energy saved if the lamps are = 600 × 10 Wh/day

working for 10 hours a day = 6000 Wh/day
= 6 kWh/day

Cost savings (₹/day) = 6×5

= 30

Cost savings per annum = 30 × 240

considering 240 working days in = 7200
an year (₹)

Simple payback period = 1600×10

7200

= 2. 22 years

Q2. EE482 October 2019 (2015 scheme)

Calculate the simple payback period for a boiler that costs Rs.75 lakhs to purchase and
is expected to save Rs.30 lakhs/ year.
Solution:
75
𝑆𝑃𝑃 = 30
= 2. 5 years
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Q3. EE482 September 2020 (2015 scheme)

A Company is planning to undertake a project requiring initial investment of $105
million. The project is expected to generate $25 million per year in net cash flows for 7
years. Calculate the payback period of the project.
Solution:
105
𝑆𝑃𝑃 = 25
= 4. 2 years

Q4. EE482 August 2021 (2015 scheme)

A new small cogeneration plant installation is expected to reduce a company's annual
energy bill by Rs.500000/-. If the capital cost of the new boiler installation is
Rs.22,20,000 and the annual maintenance and operating costs are Rs. 40,000, find the
expected payback period for the project?
Solution:
Saving’s in annual energy bill = ₹5,00,000
Annual O&M costs = ₹40,000
Annual net savings (₹) = 500000 − 40000 = 460000
2220000
𝑆𝑃𝑃 = 460000
= 4. 83 years

Q5. EE482 June 2022 (2015 scheme)

Using the net present value analysis technique, evaluate the financial merits of the two
proposed projects shown in the table and select the best project. The annual discount
rate is 8% for each project. The capital cost for project 1 and project 2 is the same and
is Rs. 30000.

Project 1 Project 2
Year
Net Annual Savings (Rs.) Net Annual Savings (Rs.)

1 6000 6700

2 6000 6700

3 6000 6700

4 6000 6700

5 6000 6700

6 6000 6000

7 6000 6000

8 6000 6000

9 6000 6000

10 6000 6000

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EET424 Energy Management - 2019 Scheme

Solution:
NPV of project 1 is calculated as follows.
−30000 6000 6000 6000 6000 6000 6000 6000 6000 6000 6000
𝑁𝑃𝑉 = 0 + 1.08
+ 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10
1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08
∴ 𝑁𝑃𝑉 = 10260. 49

NPV of project 2 is calculated as follows.

−30000 6700 6700 6700 6700 6700 6000 6000 6000 6000 6000
𝑁𝑃𝑉 = 0 + 1.08
+ 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10
1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08
∴ 𝑁𝑃𝑉 = 13055. 39

Since the NPV of project 2 is greater than the NPV of project 1, the best project is
Project 2.

Q6. EE482 October 2022 (2015 scheme)

Project X costs Rs.50,00,000 and will return a net cash inflow of Rs.17,00,000 per
period. What will be the payback period for this project?
Solution:
5000000
𝑆𝑃𝑃 = 1700000
= 2. 94 years

Q7. EE482 January 2024 (2015 scheme)

A cogeneration system installation is expected to reduce a company’s annual energy bill
by Rs. 23 Lakhs. If the capital cost of the new cogeneration installation is Rs. 90 Lakhs,
and the annual maintenance and operating costs are Rs. 5 Lakhs, what will be the
expected payback period for the project?
Solution:
90
𝑆𝑃𝑃 = 23−5
= 5 years
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Q8. EE482 January 2024 (2015 scheme)

Use the net present value technique and determine the best among the two projects
given in the following table.

Project 1 Project 2

Capital Cost (Rs.) → 30000 30000

Year Annual Net Savings (Rs.) Annual Net Savings (Rs.)

1 6000 6600

2 6000 6600

3 6000 6300

4 6000 6300

5 6000 6000

6 6000 6000

7 6000 5700

8 6000 5700

9 6000 5400

10 6000 5400

Total net savings at the

60000 60000
end of the 10th year
Solution:
Since the discount rate is not specified in the question, the assumed rate of discount is
8%. The NPV for the project 1 is calculated as
−30000 6000 6000 6000 6000 6000 6000 6000 6000 6000 6000
𝑁𝑃𝑉 = 0 + 1.08
+ 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10
1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08
𝑁𝑃𝑉 = 10260. 49

The NPV for the project 2 is calculated as

−30000 6600 6600 6300 6300 6000 6000 5700 5700 5400 5400
𝑁𝑃𝑉 = 0 + 1.08
+ 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10
1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08
𝑁𝑃𝑉 = 10873. 91

Since the NPV of project 2 is greater than the NPV of project 1, the best project is
Project 2.

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EET424 Energy Management - 2019 Scheme

Q9. EET424 June 2023 (2019 scheme)

A new small cogeneration plant installation is expected to reduce a company's annual
energy bill by Rs.4,86,000/-. If the capital cost of the new boiler installation is
Rs.22,20,000/- and the annual maintenance and operating costs are Rs.42,000,
calculate the expected payback period for the project?
Solution:
2220000
𝑆𝑃𝑃 = 486000−42000
= 5 years

Q10. EET424 June 2023 (2019 scheme)

An energy audit in a factory indicates that the total electrical consumption per year is
Rs. 5.5 x 106. By upgrading a few motors with high efficiency motors, a 15% saving in
energy can be realized. The additional cost of energy efficient motors is Rs. 4,25,000
and the installation cost is Rs. 80,000. Assuming a 15 year life cycle, is the expenditure
justifiable on a minimum return of 20%? Conduct an economic analysis using present
worth method.
Solution:
Present worth or present value (PV) is the current value of a single future cash flow or a
series of future cash flows, discounted at a specific rate.
6
​ Annual savings = 0. 15 × 5. 5 × 10 = 825000
​ Initial expense = 425000 + 80000 = 505000
15
825000
𝑃𝑉 = ∑ 𝑡 = 3857265
𝑡=1 1.2

The expenditure on upgrading to energy-efficient motors is justifiable because the

present worth of the energy savings (Rs. 3857265) exceeds the total investment cost
(Rs. 5,05,000), providing a positive Net Present Worth (NPW). This indicates that the
project will generate a return higher than the minimum required return of 20%.

Q11. EET424 June 2023 (2019 scheme)

Consider a project which has the following cash flow stream. The cost of capital for the
firm is 10%. Calculate the net present value of the proposal.
Investment Rs. 10,00,000

Year Cash flow

1 200000

2 200000

3 300000

4 300000

5 350000
COLLEGE OF ENGINEERING AND MANAGEMENT PUNNAPRA

Solution:
−1000000 200000 200000 300000 300000 350000
𝑁𝑃𝑉 = 0 + 1 + 2 + 3 + 4 + 5 =− 5276. 62
1.1 1.1 1.1 1.1 1.1 1.1

Q12. EET424 October 2023 (2019 scheme)

Calculate the energy saving and payback period which can be achieved by replacing a
11kW existing motor with an EEM. The capital investment required for EEM is Rs.
40,000, cost of energy/kWh is Rs. 5. The loading is 70% of the rated value for both
motors. Efficiency of the existing motor is 81% and that of the EEM is 84.7%.
Solution:
𝑅𝑎𝑡𝑒𝑑 𝑝𝑜𝑤𝑒𝑟 × 𝑙𝑜𝑎𝑑𝑖𝑛𝑔 11×0.7
​ Power drawn by the existing motor (kW) = 𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦
= 0.81
= 9. 506
11×0.7
​ Power drawn by the EEM (kW) = 0.847
= 9. 091
​ Annual energy savings (kWh) = (9. 506 − 9. 091) × 365 × 24 = 3635. 4
​ Cost savings per year (₹) = 3635. 4 × 5 = 18177
40000
​ 𝑆𝑃𝑃 = 18177
= 2. 2 years

Alternate method to determine the annual energy savings is given below.

​kWh savings = kW output × ( 1
η𝑜𝑙𝑑
−
1
η𝑛𝑒𝑤 ) × hours of operation

​ = (11 × 0. 7) × ( 1
0.81
−
1
0.847 ) × (365 × 24)
​ = 3637. 7

Q13. EET424 October 2023 (2019 scheme)

Calculate the internal rate of return (IRR) for a device that costs 5 lakhs which lasts for
10 years and results in fuel saving of Rs. 1.5 lakhs each year.
Solution:
IRR is equal to the discount rate (𝑟) which makes NPV=0.
10
150000
𝑁𝑃𝑉 = 0 =− 500000 + ∑ 𝑡
𝑡=0 (1+𝑟)
When 𝑟 = 0. 27, NPV = 4659 and when 𝑟 = 0. 28, NPV = -9663. Hence, the value of 𝑟
(IRR) for which the NPV=0 is in between 0.27 and 0.28, and can be determined by
using linear interpolation as follows.
4659×(28−27)
𝐼𝑅𝑅 = 27 + 4659+9663
= 27. 32%

Prepared by: Anith Krishnan

EET424 Energy Management - 2019 Scheme

10. PYQs and Answers - Theory

Q1. EE482 May 2019 (2015 scheme)
Explain the procedure for evaluating proposals using the average rate of return method.
Answer:
Step 1: Calculate the expected average annual net operating income generated by the
investment over its useful life. This is typically the average annual profit after deducting
all operating expenses, including depreciation, from the incremental revenues.

Step 2: Compute the average investment over the asset’s useful life. Average
investment can be calculated from the equation given below.
𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 + 𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒
𝐴𝑣𝑔. 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 2

Step 3: ARR is calculated using the following equation

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡
𝐴𝑅𝑅 = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑜𝑟 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
× 100
​ If evaluating multiple proposals, rank them based on their ARR. The proposal
with the highest ARR is considered the most desirable.

Q2. EE482 May 2019 (2015 scheme)

Compare simple payback method and present value method.
Answer:
Aspect Simple payback method Present value method

Time value of money Ignores the time value of Explicitly accounts for time
money value via discount rate

Cash flow consideration Excludes cash flows after Considers all cash flows
payback period over the project’s life

Ease of use Simple to calculate and Requires complex discount

interpret rate selection and cash
flow forecasting

Decision criteria Accept if payback period ≤ Accept if NPV > 0

arbitrary cutoff period