Published: Jan 1983
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Recent shortages in the availability of capital financing and accompanying high interest rates have forced industry to utilize detailed economic analyses for evaluating insulation systems and other energy conservation measures. Such analyses are intended to provide information about the relative net dollar effects of available investment alternatives.
The study period length and energy price escalation rate are two basic assumptions that must be established prior to the application of an economic evaluation technique. The study period length (the time period over which the costs of an investment are analyzed) may reflect the useful life of the investment or the time horizon of the investor. The energy price escalation rate (the rate of cost increase assumed for a given type of energy) will reflect the investor's expected inflation rate for energy costs.
Presented here are a number of graphically illustrated examples that give detailed sensitivity analyses for varied study period lengths and energy price escalation rates. It is shown that the calculated cost-effectiveness of an investment in insulation can be extremely dependent upon the study period length and energy price escalation rate selected for the economic evaluation.
The economic benefits that occur during the later years of a long study period in which the assumed energy price escalation rate is greater than the selected discount rate can cause the calculated net benefits of an investment to be even more positive than would result from an analysis of the same investment over a shorter study period. Additionally, the assumption of a positive energy price escalation rate will result in a calculated internal rate of return (IRR) for an investment that is greater by a similar number of percentage points than the IRR calculated for the same investment with no energy price escalation assumed. The assumption of an energy price escalation rate nearly equal to or greater than the minimum acceptable rate of return could thus inadvertently guarantee an acceptable calculated IRR value.
It is concluded that economic evaluations of insulation systems are particularly sensitive to the described factors, and that basic assumptions for such evaluations should always be clearly stated.
study periods, energy price escalation rates, economic evaluation, insulation systems
Project Manager, New York State Energy Research and Development Authority, Albany, N.Y.