Simple payback is a term that came into use in the 1970s by well-meaning advocates of renewable energy and energy efficiency—and it’s still in widespread use. Payback is the number of years it takes an RE system or an energy-efficiency measure to offset its cost through the savings generated.
Payback is calculated by dividing a system’s cost by the anticipated annual savings. If the $10,710 PV system used in the previous examples produces 5,000 kWh per year and grid power costs 9.5 cents per kWh, the annual savings of $475 yields a payback of 22.5 years ($10,710 / $475 = 22.5 years). Using simple payback, this system will take almost 23 years to pay for itself. From that point on, the system produces electricity for free. While a payback of nearly 23 years seems long, don’t forget that the ROI on this system, calculated earlier, was 4.4%—a respectable rate of return on your investment.
Interestingly, simple payback and simple ROI are closely related metrics. In fact, ROI is the reciprocal of payback. That is, ROI = 1 ÷ payback. Thus, a PV system with a 10-year payback represents a 10% return on investment (ROI = 1 ÷ 10). A PV system with a 20-year payback represents a 5% ROI.
Besides being economically misleading, simple payback is a concept we rarely apply in our lives. Do avid anglers ever calculate the payback on their new bass boats? ($25,000 plus the cost of fuel and transportation to and from favorite fishing spots, divided by the total number of pounds of edible bass meat at $5 per pound over the lifetime of the boat.) Have you calculated the payback on your new kitchen cabinets, swimming pool, or other consumer items?
Although payback and ROI are related, ROI is a much more familiar concept. We receive interest on savings accounts and are paid a percentage on mutual funds and bonds—both of which are a return on our investment. An RE system also yields a return on our investment by avoiding paying the utility, so it can make sense to use ROI to assess its economic performance.