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Annual SavingsYearPaid w/cashFinancedAnnual Cash FlowsNet System CostResults:7Does it make financial sense to replace an HVAC sytem?InputsAnnual loan paymentInflation RateInternal Rate of ReturnNet Present ValueFinanced (10 yrs)Financing RateDiscount Rate (real)NPV w/$600 savingsNPV w/$500 savings$9500 Financed$7500 FinancedNPV w/$400 savings*Project Cost (paid in cash)6% loan8% loan10% loan12% loan"g
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R<SCost of replacement HVAC system after subtracting any discounts or tax incentives
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<The discount rate reflects the riskiness of the project and the expected stream of cash flows from the savings that the project will generate.
This real discount rate is added to the inflation rate (above) and used in the Net Present Value calculation below.
Equipment replacement projects are considered low risk, but they're not risk free. Things good go wrong over the years that interfere with the stream of expected cash flows. A real discount rate of 1 -2% is probably a reasonable starting point.<
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1<2If financing the project is an option, enter the interest rate. The spreadsheet assumes a 10 year loan.
If your financing the project with a tax deductable loan, it probably makes sense to reduce the interest rate to account for the after-tax cost of financing [eg multiply interest rate * (1-tax rate)
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c<dThe Net Present Value formula 'normalizes' all the postive and negative cash flows from the project that are spread across multiple years so they can be added together.
The formula does this by 'discounting' each cash flow back to the present year using an appropriate discount rate. Once discounted or normalized to the current year, the positive and negative cashflows can added together.
If a project's NPV is 0 or greater, it is likely that the project will add economic value, all things considered. If the NPV is less than 0, the project is not likely to add economic value and should be reconsidered.<
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<<=The Internal Rate of Return (IRR) is the implied annual rate of return, earned over the life of the project, on the cash outlays (or negative cash flows) associated with the project.
IRR and NPV are closely related in that a project's IRR is the discount rate that would make the project have an NPV of exactly 0.
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