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when purchasing energy-efficientunits. His overall real discount rate was approximately 25%. However, when income became a variable, he found considerable fluctuation in the discount rate (i.e., households withanannualincomeof $10,000had ared discountrate of 39%,andthosewithanincomeo€$50,000 had a real discount rate of 5%). The circumstances surrounding each residential customer are different, making it difficult to determine an appropriate discount rate for the residential sector. Nonetheless, a discount rate is required. When knowledge of a specific investor is unavailable, a 10% real rate is recommended, with other factors (i.e., noneconomic) considered explicitly. Because the utility industry is largely regulated, the estimation of discount rates is more formalized and more data exists. Common utility practice is to employ a discount rate equal to the utility’s Weighted AverageCostofCapital(WACC). ThecalculationofthisWACCisexplainedinsomedetailinthenext section. In the Electric Power Research Institute’s @PH’s) 1991 Technical Assessment Guide @XI June 1993), an after-tax nominal discount rate of 9.2% for investor-owned utilities (IEOWs) is suggested inmostcasesbecauseutilitiesperformanalysesmoreQ~~XXinI currentdollarsthaninconstantdollars. The analyst should note that the 9.2% nornind discount rate may change, depending on the rate of inflation. In its calculations, EPRL assumed an annual inflation rate of 4.1%, which is a long-term average. The equivalentreal after-tax discountrate is 4.9%. Thisis significantlylessthanthe 10%suggestedfor use in the nonutility private sector and is because, as a regulated industry, utilities have little competition in their service territories and their regulated rates help ensure return on investment. Thus, there has historicdly been less risk involved in the utility sector than in other private sectors. EPRI: also suggests the use of utility before-tax discount rates of 10.8% nominal and 6.4% real. The difference between these and the after-tax discount rates presented previously reflects the fact that debt paymentsaredeductibleforincometaxpurposes. EPRIreportsthatmostutilitiesemployanafter-taxrate. Whether to use a before-tax or an after-tax discount rate will depend on the study itself. This topic is covered in more detail in the Taxes subsectionin Section 2, where it is recommended that most EE utility analyses be conducted on an after-tax basis because income taxes can have varying effects on different alternatives. Because 77% of all U.S. generating capacity is owned by IOUs (EEI October ISSl), the after-tax 9.2% nominal discount rate (or the equivalent, 4.9%real) is recommended for use in the evaluation of El3 technologies within the utility sector. However, the analyst should recognize that significant generating capacity is owned by municipal utilities and rural cooperatives that enjoy special tax status (and may therefore employ a lower nominal discount rate), and by independent power producers (IPPs) whose profits are not regulated (and who may use a higher discount rate that is closer to that of the industxial sector). Table 2-2 summarizes discount rates recommended for EE use when investor or investment-specificdata are not available. These discount rates are consistent with those used in the National Energy Strategy released by the DOE in 1993. The development of the nation’s energy options requires investments now that will produce benefits well intothefuture. Asanexample,R&Dcostingbillionsofdollarsmaynotproducebenefitsformanyyears (e.g., 30, 40, 50 years), and these benefits could potentially accrue for hundreds of years thereafter. As discussed previously, the common approach for evaluating these projects is to discount the costs and benefits to their present values. For projects in which benefits or costs occur well into the future, the discountrateusedfortheanalysiswillhaveastrongimpactontheresults. Asanextremeexample,the cost of nuclear waste and contamination may accrue several hundred if not thousands of years from now, and any positive discount rate would allow for even devastating costs to kture generations to be insignificant in terms of present value ( L i d 1982). 8PDF Image | A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies
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