LUT University/ENTE

BH61A0201 Energy Economics

BH61A020E Energy Economics for EnTeDI

EXERCISE 1
Solutions

PROBLEM 1.

Evaluate the profitability of CHP plant investment.

Initial values

Investment cost Isp 13 million €

Operation and maintenance costs Kom 200 000 €
Fuel costs hfu 22 €/MWhfu
Total system efficiency ηtot 0,85%
Heat production EH 50 GWh/year
Electricity generation Eel 16 GWh/year
Electricity price hel 50 €/MWh
Heat price hH 42 €/MWh
Discount rate i 5 %
Economical lifetime n 25 years

The Net present value NPV of an investment project is calculated as

𝑆𝑡 𝐽𝐴
𝑁𝑃𝑉 = ∑𝑛𝑡=1 − (𝐼 − (1+𝑖)𝑛 𝑛 ) ≥ 0 (1)
(1+𝑖)𝑡

where
St net cash inflow-outflows (net savings or net income) in year t, €
i discount rate of interest, %
t year
I investment cost, € (in the end of year 0 or in the beginning of year 1)
JAn salvage value of the investment at the end of lifetime, €
n Investment lifetime.

Annual cash flows can be described as follows over the 25 years’ time as shown in the figure:

S1 S2 S23 S24 S25

Investment I
n = 25 years

present moment
(t = 0)
Salvage value (JAn) is usually assumed zero for power plant investments. Here we have
constant annual net income (electricity production is assumed to be same every year). So,
Net present value NPV can be written as
𝑁𝑃𝑉 = 𝑎𝑛,𝑖 ∙ 𝑠 − 𝐼 (2)
where
(1+𝑖)𝑛 −1
an,i = = present value factor of periodic payments
𝑖∙(1+𝑖)𝑛
s = annual net income, €/year (same amount each year)
I = investment, €.
In Net present value method, the investment is profitable, if the net present value of the
investment is positive (or zero).

Annual costs and savings:

First solve the fuel needed to produce the electricity (Eel) and heat (QH):
𝐸𝑒𝑙 + 𝑄𝐻 16 𝐺𝑊ℎ⁄𝑦𝑒𝑎𝑟 + 50 𝐺𝑊ℎ/𝑦𝑒𝑎𝑟
𝐸𝑓𝑢 = = = 77,65 𝐺𝑊ℎ/𝑦𝑒𝑎𝑟
𝜂𝑒𝑙 0,85
Fuel costs:
€
𝐾𝑓𝑢 = ℎ𝑓𝑢 ∙ 𝐸𝑓𝑢 = 22 ∙ 77,65 ∙ 103 𝑀𝑊ℎ/𝑦𝑒𝑎𝑟 = 1 708 235 €/𝑦𝑒𝑎𝑟
𝑀𝑊ℎ
Total expenses
€ € €
𝐾𝑡𝑜𝑡 = 𝐾𝑓𝑢 + 𝐾𝑜𝑚 = 1 708 235 + 200 000 = 1 908 235
𝑦𝑒𝑎𝑟 𝑦𝑒𝑎𝑟 𝑦𝑒𝑎𝑟
The energy company gets savings, because it doesn’t have to buy the electricity and heat, and
instead produces the energy needed in an own CHP plant. The savings due to the electricity
and heat production are solved as
€ 𝑀𝑊ℎ € 𝑀𝑊ℎ
𝑇 = ℎ𝑒𝑙 ∙ 𝐸𝑒𝑙 + ℎ𝐻 ∙ 𝑄𝐻 = 50 ∙ 16 ∙ 103 + 42 ∙ 50 ∙ 103
𝑀𝑊ℎ 𝑦𝑒𝑎𝑟 𝑀𝑊ℎ 𝑦𝑒𝑎𝑟
= 2 900 000 €/𝑦𝑒𝑎𝑟

Yearly net income s = Annual savings T – total annual expenses Ktot:

s = T- Ktot = (2 900 000 – 1 908 235) €/year = 991 765 €/year.

Net present value of the investment project: 𝑁𝑃𝑉 = 𝑎𝑛/𝑖 ∙ 𝑠 − 𝐼

Present value factor of periodic payments an,i:
(1 + 𝑖)𝑛 − 1 (1 + 0,05)25 − 1
𝑎𝑛,𝑖 = = = 14,093945
𝑖 ∙ (1 + 𝑖)𝑛 0,05 ∙ (1 + 0,05)25
Net present value of the investment project:
NPV= 𝑎𝑛/𝑖 ∙ 𝑠 − 𝐼 =14,093945 · 991 765 €/year – 13· 106 € = 977 877 €
As the Net present value of project is positive, the project is profitable.
b) Sensitive analysis
The technique used to determine how independent variable values will impact a particular
dependent variable under a given set of assumptions is defined as sensitive analysis.
Sensitivity analysis is also referred to as "what-if" analysis and is a way to predict the
outcome of a decision given a certain range of variables. By creating a given set of variables,
an analyst can determine how changes in one variable affect the outcome.
In sensitivity analysis it is possible to assess the impact of the variables such as investment
cost, rate of interest, economical lifetime of the power plant or the price of fuel, electricity, or
emission allowances.
Here sensitivity analysis concerns investment cost, electricity price and fuel price. -20 % and
+20 % changes are calculated for the variables, one at a time. Meanwhile, other variables are
kept as original values. The net present value of the investment project is solved to see the
impact of the changes on the profitability of the investment project.
Sensitivity analysis helps to find the variables, which have the largest effect on the profitability
of the investment.

For example, the investment cost is varied -20% (I = 10,4 m€) and +20% (I = 15,6 m€). Other
values are kept as they are. Net present value of the project is calculated for both cases, which
can be seen in the table 1 below.
Investment cost changes -20 %: I = 0,8 · 13 · 106 € = 10,4 · 106 €
NPV= 𝑎𝑛/𝑖 ∙ 𝑠 − 𝐼 =14,09394 · 991 765 €/a – 10,4 · 106 € = 3 577 877 €
Investment cost changes +20 %: I = 1,2 · 13 · 106 € = 15,6 · 106 €
NPV= 𝑎𝑛/𝑖 ∙ 𝑠 − 𝐼 =14,09394 · 9j91 765 €/a – 15,6 · 106 € = -1 622 123 €

Table 1. Sensitivity analysis of the investment project changing investment cost.

Investment
-20 % 0 +20 %
I [m€] 10,4 13 15,6
NPV [m€] 3,578 0,978 -1,622

The same is done with electricity price, see the table 2 and fuel price (table 3).

Table 2. Sensitivity analysis of the investment project changing electricity price.

 Electricity price
-20 % 0 +20 %
hel €/MWh 40 50 60
T m€/year 2,740 2,900 3,060
s m€/year 0,832 0,992 1,152
NPV m€ -1,277 0,978 +3,233

Table 3. Sensitivity analysis of the investment project by changing the fuel price.
Fuel price
-20 % 0 +20 %
hfu €/MWh 17,6 22 26,4
KFu €/year 1,367 1,708 2,050
s m€/year 1,333 0,992 0,650
NPV m€ +5,793 +0,978 --3,837

c) Sensitivity analysis graphically

In the figure below, the net present value of the investment is shown as a function of the
percentage change in investment cost, electricity price or fuel price.

Figure 1. Graphical sensitivity analysis of the investment.

Sensitivity analysis shows that fuel price has significant effect on the profitability of the
project. Therefore, accuracy of the fuel price estimation should be the first priority in
profitability calculation.
PROBLEM 2.
Secondary heat for paper machine hood
Secondary heat is planned to be used for heating the replacement air of the paper machine
hood instead of back-pressure steam.
Find a) Cumulative discounted net cash-flow calculation
Is the investment project profitable?
What is the net present value of the project if economical lifetime is 8 years?
What is the repayment time with interest?

b) Repayment diagram (line graph) based on cumulative discounted net cash-flow

Initial values
availability time t 7 months/year
air mass flow (to be heated) qm,i 58 kg/s
air temperature difference ΔT (60-38) K
air specific heat capacity cp 1,01 kJ/kgK
steam price hH 3,6 €/GJ
investment cost I 500 000 €
annual additional costs hadd 5 000 €/year
discount rate of interest i 5 %
economical lifetime n 10 years

Savings due to replacement of back pressure steam:

Thermal power:

𝑘𝑔 𝑘𝐽
Φ = 𝑞𝑚,𝑖 ∙ 𝑐𝑝 ∙ Δ𝑇 = 58 ∙ 1,01 ∙ (60 − 38)𝐾 = 1289 𝑘𝑊
𝑠 𝑘𝑔𝐾

Thermal energy:

7 ℎ
𝑄 = Φ ∙ 𝑡 = 1289 𝑘𝑊 ∙ ∙ 8760 = 6586 𝑀𝑊ℎ/𝑦𝑒𝑎𝑟
12 𝑦𝑒𝑎𝑟

Heat price in [€/MWh]: 1 MWh = 3600MJ ([W]=[J/s], 1h=3600s)

€ 𝐺𝐽 € €
ℎ𝐻 = 3,6 ∙ 3600 = 12 960 = 12,96
𝐺𝐽 𝐺𝑊ℎ 𝐺𝑊ℎ 𝑀𝑊ℎ

Annual savings:
€ €
𝑆 = 𝑄 ∙ ℎ𝐻 = 6586 𝑀𝑊ℎ/𝑦𝑒𝑎𝑟 ∙ 12,96 𝑀𝑊ℎ = 85 349 𝑦𝑒𝑎𝑟
Annual net savings

Snet = S - hadd = 85 349 €/year – 5000 €/year = 80 349 €/year

Cumulative discounted net cash flow

To get cumulative discounted net cash flow, annual net savings are discounted one by one at
the discount rate. Present value factor for the individual payments (discount factor) vt,i
𝟏
=(𝟏+𝒊)𝒕 is used, where i is the discount rate of interest and t is the year. It can be found in table
too.

Present value factor vt,i is calculated for each year. The savings in each year are multiplied by
the corresponding present value factor.

Cumulative discounted net cash flow is solved by adding the present value of savings of year
t+1 to the net cash flow of year n:

Present
Net value Cumulative
Inv. Savings Discount of savings discounted
Year I Snet factor Snet· vt,i net cash flow
t € € vt,i € €
0 500 000 -500 000
1 80 349 0,9524 76 523 -423 477
2 80 349 0,9070 72 879 -350 598
3 80 349 0,8638 69 408 -281 190
4 80 349 0,8227 66 103 -215 086
5 80 349 0,7835 62 956 -152 131
6 80 349 0,7462 59 958 -92 173
7 80 349 0,7107 57 103 -35 071
8 80 349 0,6768 54 383 19 313
9 80 349 0,6446 51 794 71 106
10 80 349 0,6139 49 327 120 434

The net present value of the project for t = n = 10 is + 120 434 €.

➔ Since the discounted cash flow is positive, the investment is profitable.

The net present value of the project for t = n = 8 is +19 313 € (See the table)

(Or using the net present value expression NA = an,i · S – I

(1+𝑖)𝑛 −1 (1+0,05)8 −1
ani = = 0,05∙(1+0,05)8 = 6,4632
𝑖∙(1+𝑖)𝑛

➔ NPV = an,i · S – I = 6,4632 · 80 349 € -500 000€ = 19312 €)

Repayment time with interest from above table through linear interpolation:
Year Cumulative discounted
𝑥−7 0−(−35071) net cash flow €
= 7 -35 071
8−7 19313−(−35071) x 0
8 19 313

35071
➔ 𝑥 = 7 + 54383 ≈ 7,6 𝑦𝑒𝑎𝑟𝑠

(Or using net present value expression NPV = an,i · S – I = 0

ani = I/S = 500 000 € / 80 349 € = 6,2229

Present value factor of periodic payments:

(1+𝑖)𝑛 −1
➔ ani = 𝑎𝑛,𝑖 = = 6,2229 , where i = 0,05
𝑖∙(1+𝑖)𝑛
Resolve n -> Repayment time with interest is n ≈ 7,6 years)

b) Repayment diagram:

Repayment diagram
200 000
Cumulative discounted net cash flow, €

100 000

0
0 1 2 3 4 5 6 7 8 9 10
-100 000

-200 000

-300 000

-400 000

-500 000

-600 000
year

Cumulative discounted net cash flow