# Should payback periods take the time value of money into account?

I am currently reviewing a paper estimating the payback period for different building renovation strategies.

The calculations I see typically go something like this: you pay (say) USD 3000 today, save USD 300 per year in energy savings, ergo there is a 10 year payback period.

However, shouldn't future energy savings be discounted according to the Time Value of Money?

• Can you link to the paper, or give us some more information about the scope of the analysis? I can envision this simply being a finance question, having nothing to do with sustainability, really. Or, it could grow to encompass all sorts of factors, and 2nd-order effects.
– Nate
Sep 13 '13 at 1:36
• payback period is hard to calculate, and there's a lot more factors than time value of money. I'd be slightly concerned that the paper misses more of them if they missed something this obvious. Is this pre-pub so you can't link to it?
– Móż
Sep 18 '13 at 5:43

Yes, in developing business cases for renovation strategies, it is normal to include a cost of money, to calculate the Net Present Value. It gets slightly difficult when trying to create a standard business case, because different households have different time values of money.

One can also calculate a Net Present Value by discount future benefits and non-cash costs, and that may differ from the current cost of money. Be aware that this can be controversial: see, for example, the discussion around the Stern Review's choice of discount rate for future harm from climate change.

So the calculation you've presented, in the paper you are reviewing, looks naive. It's missing out on the cost of money. It's also missing out on likely changes in the value of future energy savings, as the cost of energy is likely to change in the future. It might be that the author/s assumed that the two effects would cancel out (i.e. real increases in future energy prices would match the cost of money), but that's quite a hefty simplifying assumption, and I'd expect to see a statement of the assumption in the paper.

### Warmth-taking

How much energy is actually saved by renovation varies hugely, and almost never matches the energy savings predicted in advance. There's a phenomenon that's been called variously: comfort-takeback, rebound, warmth-taking, the Khazzoom-Brookes postulate, the Jevons paradox. Essentially, after renovation designed to prevent heat loss, energy used for heating doesn't drop as much as was expected. There are a bunch of putative explanations for this, and there isn't a single right explanation, nor is there a reliable estimate of how large the effect will be.

### Non-cash benefits

And that lack of clarity over warmth-taking brings me to another element usually missed from calculations of the value of renovation: the changes to quality of life that ensue from the renovation. Those can go either way, and might include:

• higher security (against crime);
• lower exposure to noise pollution and air pollution from outside;
• higher exposure to pollutants sourced in or under the home (e.g. smoke, radon)
• changes to internal CO2 levels
• changes to risk and prevalence of mould and dust mites.
• IME the non-cash benefits often dominate, and specifically the one you left out - comfort. Living in a house that's more comfortable is much more pleasant than people who don't often appreciate. This is especially the case with insulation - there's a range of temperatures that are not comfortable, but not really uncomfortable enough to justify heating/cooling. Those times tend to shrink dramatically in a decently designed or renovated building.
– Móż
Sep 18 '13 at 5:42