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Internal Rate of Return (IRR) of a Photovoltaic Solar System

Many people ask about the payback period of a photovoltaic solar system.
Another way to look at it is to ask the question:

"If, instead of buying a photovoltaic solar system, I put the same amount of money into an investment, what return would I have to receive in order to pay for the electricity the solar electric system would have provided.......?"

The rate of this return is called the Internal Rate of Return or IRR.

solar_panelsWhen you invest in a solar system, you receive non-taxable dividends each year in the form of the cash that is no longer being paid to the utility company. This is true for the Monterey Bay Area including Monterey County, Santa Cruz County and San Benito County, reaching the following cities: Monterey, Santa Cruz, San Benito, Salinas, Salinas Valley, Carmel, Carmel Valley, Pacific Grove, Santa Cruz, and Central California with these solar savings. The solar panel system has an internal rate of return higher than the yield achievable through most other investments (see table 1). In other words, if you put money equal to the net cost of a solar energy system into an investment, and withdraw the money to pay your utility bills, you have to receive a return equal to the solar IRR on a tax-free investment (or equal to the Taxed Equivalent Rate on a taxable investment) to perform financially as well. For further information, local climate data, and typcial energy costs in California please read Payback and Other Financial Tests.

Table 1

Electricity Rate Inflation* Solar Internal Rate of Return Taxed Equivalent Rate**
-2% 10.4% 15.4%
-1% 12.6% 18.4%
0% 14.8% 21.6%
1% 16.8% 24.8%
2% 19.0% 28%
5% 25.4% 37.4%

*The historical average rate of inflation for electricity rates has been 2%. PG&E's "Average Retail Electricity Prices" have averaged 5.15% annual increases from 1980 to 2013, rising from 4.79 cents/kwh in 1980 to 21.00 cents/kwh in 2013 (source: http://www.eia.doe.gov/cneaf/electricity/epm/table5_6_b.html).
**assuming a marginal tax rate of 32%
Other assumptions:
a. Each peak kilowatt of solar panels will yield 1443 kwh of solar electricity per year
(this is a conservative estimate. many sources use a figure of 1750 to 1950 kwh).
b. Electricity produced is displacing Tier V consumption valued at $0.413/kwh.
c. Solar energy system costs $3491 per kilowatt and has a lifetime of 30 years. A federal tax credit is pending which will reduce this, effectively increasng the IRR. Most solar panels are warranteed by their manufacturers for 25 years.
d. Solar system has no value at the end of 30 years. In fact, the solar energy system may keep operating for many years after that, producing free electricity.

Since savings on utility charges are not taxable, the fair comparison is with an investment's after-tax returns. The rate of a taxed investment which will provide the necessary returns is listed as "Tax Equivalent Rate".

Such calculations show a solar energy system to be a good investment. There are some unknowns, such as the future price of electricity, and some variables, such as the homeowner's marginal tax rate and the size and cost of the PV system, but the following examples show some interesting results for two different scenarios. The projection for your house will depend on your consumption patterns and tax status - contact us for a free personal analysis by email at
Picture of email address or by phone at 831-333-1919.

For example, a home averaging 566 kilowatt-hours per month putting in a 2 kilowatt solar panel system will get economic benefits equal to an investment paying 18.8%, assuming electrical rates rise at one-half their historical rates and they only get the current 30% tax credit. (See Table 2)


Table 2: Replacing Tier III and IV electricity, with 30% tax credit (California or Federal)
Returns as a function of electricity rate inflation
Electricity Rate Inflation  -2%  -1%  0%  1%  2%  3%  4%  5%
PV IRR  6.4%  8.6%  10.6%  12.8%  14.8%  17.0%  19.0%  21.2%
Taxed equivalent rate 9.4% 12.6% 15.6% 18.8% 21.8% 25.0% 28.0% 31.2%
Assumed Values for Variables
32% Marginal Tax Rate
1.98 kilowatt peak capacity System size
2887 kilowatt-hours Annual solar panel production
$5850 Solar Energy Cost (after CEC rebate, and 30% tax credit)
$0.32 per kwh Current electricity rate for replaced power *
* (Tier III and IV, with surcharges)

If the home averages 1000 kilowatt-hours per month, the pending Federal tax credit is signed into law and rates rise at their historical 2%, a 2 kilowatt solar system will yield the equivalent of an investment paying 18.4%. (See Table 3) If you use a lot of electricity, even if rates DECLINE at 2% per year, a solar system is as good as a bank account paying 23.8%!


Table 3: Replacing Tier V electricity, with 30% tax credit (California and Federal)

Returns as a function of electricity rate inflation
Electricity Rate Inflation  -2%  -1%  0%  1%  2%  3%  4%  5%
PV IRR  16.2%  18.4%  20.6%  22.8%  25.0%  27.2%  29.4%  31.6%
Taxed equivalent rate 23.8% 27.0% 30.2% 33.6% 36.8% 40% 43.2% 46.4%
Assumed Values for Variables
32% Marginal Tax Rate
1.98 kilowatt peak capacity System size
2887 kilowatt-hours Solar Energy Annual Production
$5850 Solar Cost (after CEC rebate, and 30% tax credits)
$0.350 per kwh Current electricity rate for replaced power *
* (Tier V, with surcharges)

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