The payback method is a practical method of financial appraisal that is widely accepted, used and easily understood.
The economic benefit of installing a CHP unit on any particular site arises out of the relationship between annual operating cost savings and capital outlay. The annual cost savings must be sufficient to meet the requirements for return on the capital invested by the owners of the plant. A number of financial appraisal techniques are available: these are outlined below.
Payback is defined as the period at the end of which the cumulative cost savings equal the capital cost. It is often called ‘simple payback’ because it does not require any assumptions about the project in terms of timing, lifetime or interest rates. The only complication is whether it is measured from the beginning of the project or from commissioning/completion.
The advantages and disadvantages of payback are summarised in the table below. Its main disadvantage is that it does not take into account the ‘time value’ of money – an important consideration for long-term projects such as CHP. However, payback is a practical method of financial appraisal that is widely accepted, used and easily understood. It is particularly useful for summarising the conclusions of feasibility assessments and also for comparing the relative viability of similar projects.
It is commonly used by industrial companies as a means of assessing short-term projects: for CHP plants, it is a useful way of putting different plant options in order of financial merit.
However, the simple payback technique does have its limitations. It does not take into account the timing of the capital outflow, the lifespan of the project, inflation, taxation or the cost of financing the investment. A more comprehensive technique, for example the discounted cash flow technique, will be used later in the evaluation procedure.
Advantages and disadvantages of payback as a method of financial appraisal
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