Question

Griffin Industries is evaluating whether to invest in solar panels to provide some of the electrical needs of its main office building in Ann Arbor​, Michigan. The solar panel project would cost $700,000 and would provide cost savings in its utility bills of $65,000 per year. It is anticipated that the solar panels would have a life of 15 years and would have no residual value.

1.	Calculate the payback period in years of the solar panel project.
2.	If the company uses a discount rate of 10​%, what is the net present value of this​ project?
3.	If the company has a rule that no projects will be undertaken that have a payback period of more than five​ years, would this investment be​ accepted? If​ not, what arguments could the energy manager make to try to obtain approval for the solar panel​ project?
4.	What would you do if you were in charge of approving capital investment​ proposals?

Answer 1

Solution 1: Calculation of Payback Period:

Year	Annual Cost Savings $	Cumulative Annual Cost Savings $
1	65,000	65,000
2	65,000	130,000
3	65,000	195,000
4	65,000	260,000
5	65,000	325,000
6	65,000	390,000
7	65,000	455,000
8	65,000	520,000
9	65,000	585,000
10	65,000	650,000
11	65,000	715,000
12	65,000	780,000
13	65,000	845,000
14	65,000	910,000
15	65,000	975,000

The Initial Investment is $700,000

We see that project recovers $700000 from the savings in between 10^th year and 11^th year

Payback period

= Completed number of years + (Amount to be recovered / Cost savings for the next year)

= 10 + (50,000/65,000)

= 10.77 Years

Solution 2: Calculation of Net Present Value

Year	Annual Cost Savings $	Present value factor @ 10%	Present Value of the Cost Savings
1	65,000	0.909091	59,090.91
2	65,000	0.826446	53,719.01
3	65,000	0.751315	48,835.46
4	65,000	0.683013	44,395.87
5	65,000	0.620921	40,359.89
6	65,000	0.564474	36,690.81
7	65,000	0.513158	33,355.28
8	65,000	0.466507	30,322.98
9	65,000	0.424098	27,566.35
10	65,000	0.385543	25,060.31
11	65,000	0.350494	22,782.10
12	65,000	0.318631	20,711.00
13	65,000	0.289664	18,828.18
14	65,000	0.263331	17,116.53
15	65,000	0.239392	15,560.48
		Total Present Value of the Cost Savings $	494,395.17

Net Present Value = Total Present Value of the Cost Savings $ - Initial Investment $

                                       = 494,395.17 - $700,000

                                       = -$205,604.83

As the Net Present Value of the project is negative, it is not recommended to invest in the solar panels

Solution 3: If the company has a rule that no projects will be undertaken that have payback period of more than 5 years, then investment in solar panels is not recommended as it has a payback period of 10.77 years and also the Net Present Value of the project is negative.

Solution 4: Being incharge of the project I would have rejected the proposal looking at a long payback period of 10.77 years and a negative NPV of $205,604.83.