Problem 1.

Going Solar?

I would like your help in evaluating whether ?going solar? is a good investment for me to undertake. Solar City offers a 20 year ?pre-pay? contract, where I pay $13,000 up front (at t=0) in exchange for 20 years worth of energy production from solar panels which they install on my roof (they also take care of maintenance). My current usage patterns as well as the details of the contract are as follows:

?My annual usage is 7,200 kilowatt hours (kwh). I expect this to remain constant overtime.

?The (average) rate that I expect to pay PG&E is 0.24$/kwh at t=1. I expect that this rate will increase roughly 3% per year.

? The solar system they can install on my roof will produce 6,500 kwh in the first year. Overtime, the panels deteriorate and so annual energy production will decrease at roughly 1%per year.? The panels will not provide enough energy to cover my annual usage. However, I can purchase the remaining energy that I need to maintain my current usage from PG&E at the same rate as above.

? At the end of the contract (t=20), the panels will be removed at no cost to me.

? The initial $13,000 prepayment is not tax deductible.

To simplify the analysis, let?s assume that I will make annual payments to PG&E with the first payment due at t=1 for the energy consumed over the next 12 months (from t=0 tot=1). If I install the panels, my up front payment to Solar City will occur at t=0. Also, my home equity line of credit has a before-tax rate of 4.2% with interest payments that are tax deductible. My marginal tax-rate is 30%. Go to the course web page and download my ?Howto Get Started? Excel spreadsheet posted under Module 9. I set up the rows and columns for you, but you will have to fill in the numbers.To answer my question:

1. First, lay out the nominal cash flows of all payments that I will make to PG&E over the next 20 years if I do not install the panels.

2. Next, lay out the nominal cash flows of all the payments that I will make to both Solar City and PG&E if I do install the panels.

3. Finally, construct the incremental cash flows associated with installing the panels. What is the IRR of installing panels? What is the NPV? Do the two decision rules agree? What would you recommend?

4. Conduct sensitivity analysis on the deterioration rate of the energy produced by the panels. Specifically, at what rate does this become a break even investment? Based on this, are you comfortable with the decision in part (c)?

Problem 1 usage price growth rate of PGE price before tax discount rate depreciation rate after tax discount rate (a) (b) t Rate per kwH CF to PGE 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 (d) (c) Pay cash for panels Solar Energy Residual Pmt to PGE CF Incremental CF NPV IRR NPV and IRR R rules agree. They both say it is a good idea to install the panels