Project Economics

Modified Accelerated Cost-Recovery System (MACRS)

Businesses can recover investments in certain property through depreciation deductions. The MACRS establishes a set of class lives for various types of property, ranging from three to 50 years, over which the property may be depreciated. For solar, wind, and geothermal property placed in service after 1986, the current MACRS property class is five years. With the passage of the Energy Policy Act of 2005, fuel cells, microturbines, and solar hybrid lighting technologies are now classified as 5-year property as well. 26 USC § 168 references 26 USC § 48(a)(3)(A) with respect to classifying property as "5-year property" and EPAct 2005 added these technologies definition of energy property in § 48 as part of the business energy tax credit expansion.

For more information, see IRS Publication 946, IRS Form 4562: Depreciation and Amortization, and Instructions for Form 4562. The IRS web site provides a search mechanism for forms and publications. Enter the relevant form, publication name or number, and click "GO" to receive the requested form or publication. Source: The Database of State Incentives for Renewable Energy: www.dsireusa.org

Internal Rate of Return (IRR)

A financial calculation that compares the present value of a project’s expected revenues with the present value of its expected costs. The IRR calculation is used to determine the discount rate at which the two values are equal. By doing this calculation, investors are able to see the project’s expected rate of return. The IRR will be a number where revenue exceeds the costs of financing the project. This means a surplus will remain after paying for the capital, and the investors will benefit from the investment. If the IRR is less than the cost of capital, the investors are not likely to participate in the project.

Discount Rate

1) The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank. 2) The ineterest rate used in determining the present value of future cash flows.

Depreciation

An accounting method used to attribute the cost of an asset over the span of its useful life. The cost, of a portion thereof, can be assigned as a loss on the project's balance sheet to reduce the tax base of the project.

Debt vs. Equity

An amount of money borrowed and owed by one party to another is considered debt. For example: bonds, loans, and commercial paper. Equity is a term whose meaning depends very much on the context, but in general, it refers to ownership in any asset after all debts associated with that asset are paid off.

Debt-to-Capital Ratio

A measurement of a company's financial leverage, calculated as long-term debt divided by long-term capital. Total debt includes all short-term and long-term obligations. Total capital includes all common stock, preferred stock, and long-term debt. This capital structure ratio can provide a more accurate view of a company's long-term leverage and risk, since it considers long-term debt and capital only. By excluding short-term financing in its calculation, the ratio provides an investor with a more accurate look into the capital structure a company will have if they were to own the stock over a long period of time.

Debt Service Coverage Ratio (DSCR)

The ratio of net operating income to the amount of money that is required to make regular debt payments. A DSCR of greater than one means that the project is taking in enough income to cover payments on loans. A number of less than one means that the project will have to dip into reserves or other financial resources to cover debt payments. Lending institutions generally frown on lending to projects that have a DSCR of less than one.

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