RENEWABLE ENERGY INVESTMENT RISK ANALYSIS FOR LOW-CARBON CITY... 172.4 data and methodology
To analyse the effects of FIT and other policies on renewable energy
investments, this paper examines the differences between expected returns
and risks under various FIT conditions. It also analyses investment returns
and risks by examining net present value (NPV) and internal rate of return
(IRR) measures using the discounted cash flow (DCF) method. The DCF
method is used as an investment analysis and evaluation model (Kettunen
et al. 2011 ). The NPV can be used to estimate future cash flows, and the
IRR can be used to determine investment benefits by estimating operating
revenue rates against investments. The larger the revenues from business
gains and the faster the returns from revenues, the higher the IRR value
obtained. In the case of solar PV, an IRR value that exceeds 10 % before
tax and 7–8 % after tax is preferred (METI 2012a, b).
The NPV of the renewable energy project is determined as follows:
NPV
CF
=
()+- =
å
tT t
t
iI
11(2.1)
where CF is the cash flow of solar PV, I the investment, i the interest rate,
and t the time.
IRR is calculated by determining the discount rate through which NPV
becomes 0 [Eq. (2.2)]. In other words, the interest rate return on invest-
ment is plus or minus 0. A comparison between the interest rate and the
IRR of the discount rate can serve as an indicator of investment decisions.
NPV
CF
irr=-
()+=
=I å
tT t
t
1 10
(2.2)Although NPV and IRR can be used to assess future investment returns,
NPV calculations are designed to serve as projections of only one scenario
and of one possible future expectation. However, in the business world, there
are numerous components of future cash flow uncertainty (Blyth et al. 2007 ;
Fleten et al. 2007 ; Yang et al. 2008 ). Thus, the Monte Carlo method can be
used to evaluate various values rather than only one value of expectation and
thus can evaluate NPV by using a system of random numbers for simulations.