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A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies

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A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies ( a-manual-economic-evaluation-energy-efficiency-and-renewable )

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2 Fundamentals This section includes an overview of the basic concepts and elements of economic and financial analysis. These fundamentals include cash flows, inflation rates, discount rates, cost of capital (including weighted average cost of capital and marginal cost of capital), present value, taxes and depreciation, fixed charge rates, financing, and risk and uncertainty. Cash Flows Introducfion Cash flows are an integral part of most analyses and are needed to compute the economic measures describedlaterinthemanual. Itisdifficulttoexplicitlydefineacashflowbecausethetypeofcashflows used for an analyses will vary, depending on the type of analysis conducted (e.g., after-tax cash flows, before-tax cash flows, incremental cash flows, and so forth). Cash flows can be thought of in terms of three different activities performed by a company: operating, investing, and financing. Cash flows from operating activities include all revenues captured, minus operatingandmaintenanceexpenses,interestpaid,andincometaxespaid. Investingactivitycashflow includes capital expenditures, and financing activity cash flow includes repayment of debt principal and dividends. Again, the specific type of analyses being performed will dictate the cash flow to be used. In the individual sections of this manual, detail is provided as to which cash flows are appropriate, given the analysis and investor perspective. Discussion Great efforts to be precise when describing the timing of costs and benefits in a cash flow series may not beworthwhileinanalysesofdevelopingtechnologiesorofdeploymentsprojectedfarintothefuhrre. For example, an economic evaluation of an investment may cover a 30-year span, but even though costs and benefits will occur at different times throughout that time, representing complex cash flows in a more simple conforming pattern (i.e. annually) sacrifices little accuracy in most cases. Commonly, cash flows occurring within a period are grouped as a lump sum at the beginning, middle, or endoftheperiod. Thismama3assumesthemostcommonpractice,whichisend-of-the-periodcashflows. Most capita3 investment analyses define a "period" as a year (Ruegg and Marshall 1990). As such, compounding or discounting the cash Rows for the analyses can be performed using an m u d discount rate (discussed in the Discount Rates subsection in Section 2). Inflation Rates Infroduction Costsandrevenuescanbeexpressedeitherin"current"dollarsor"constant"dollars. Actualcashflows observed in the marketplace are called current dollar cash flows. They represent the actual number of dollarsrequiredintheyearthecostisincurred. Currentdollarcashflowswillchangeovertimebecause of inflation (or deflation). Constant dollar cash flows @,) represent the number of dollars that would 2

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