Analyzing cash flows against invested capital

Back in college, I took a course in engineering economics. I still have the textbook upstairs. I remember learning how to draw cash flow diagrams to solve problems.

Essentially, you draw one large arrow anytime you are either investing a big chunk of change or cashing on a big sale. The arrow stems downwards if its an investment, because you are effectively losing the money in present.

This is followed by a series of short arrows usually on a yearly basis, to represent the return on your investment. If you made an investment, you would have a big negative arrow. The tiny positive arrows represent your payback, i.e. yield. Essentially, at some point in the future, the small positives add up and exceed the big negative.

And that’s the thing. Everything you do with money is essentially either plunking down a fistful of cash for small paybacks, or doing the opposite by making lots of small payments to receive something of big value later on. Anything you do must be weighed on whether the rate of payback is in your favor.

Case study – cost analysis of solar power cells

Something that I was always interested in was installing an array of solar cells on the roof of my house in order to offset the monthly electric bill. People all over the internet are eager to share their story of how they installed a solar array and knocked their bill to but a fraction or even to zero.

I wanted to do the same. But before I moved a penny, I started researching what it would cost me. And I wanted to know when I would have saved enough to pay it all off. The answer shocked me and caused me to scrap the whole idea.

Solar power cells essentially go at the rate of \$4 per Watt. Spend \$4000, and you get an array that will yield 1kW of power. I looked at my current power bill at the time and noticed that the rate about about \$0.10 per kW-hour. Another nugget of knowledge is that back then, I lived in Florida. I visited a web site and figured that in Florida, you get an effective five hours of sunlight each day.

The calculation is quite simple.

1. A 1kW solar array at \$4000/kW divided by \$0.01/kW-hour at existing rates = 40,000 hours to break even
2. 40,000 hours divided 5 hours/day = 8000 days
3. 8000 days / 365 days/year = 21.9 years

To break even with existing cost of electricity, I need almost 22 years. This is where a big negative arrow of \$4000 needs 22 tiny arrows of about \$182 in cost savings. I have read that panels are insured for up to 25 years, but that is cutting it close. What if the panel lives up to its 25 year lifespan? Will it have been worth it to have invested \$4000 in today’s dollars to have netted \$547? Over 25 years, that renders an annualized growth of 0.5%. That is way less than the inflation’s 3% rate.

It would be more cost effective to take \$4000, buy some shares of VNR stock, and use the monthly dividends to pay the power bill. The solar cell would save me \$0.50/day or \$15/month. \$4000 of VNR stock would yield about \$28/month and probably grow in value and increased dividend payments down the road.

That is when I shelved the whole idea of buying solar power cells as the means to save on power bills. If you want to do it to help reduce pollution, but all means pursue it. But don’t take it on as a great money saver. It isn’t.

FYI: This doesn’t include installation costs which sometimes doubles the entire procedure. And even if you factor in a 30% credit on the entire installation, it still comes out costing more than \$4000/kW.

Bottom line

This article isn’t about the cost of solar power cells. It is how everything you do with money needs to investigated on whether it produces the yield you think it does. It’s critical you find the break even point. Some things, like loans, break even when you have paid it all off. In that case, the emphasis is on the rate you are paying. Is there some other way you could invest the money and come up with a better rate, i.e. usage of your money.

I have a HELOC costing me 4%. I also have an investment that yields almost 9%. When it has completely paid off the HELOC, the yield will continue all the way into retirement, and hopefully, as a legacy to my wife and children. In the end, I will end up with more harvested money than if I had simply taken all that cash and paid off the HELOC immediately. I might have paid interest along the way, but eventually my stock will produce enough cash to have even paid for all that interest and still be producing money.