This article will address the most common error that developers and EPCs make when modeling commercial solar PPAs. The video below will discuss the problem, the solution, and provide a free tool you can download so you can work through the answer yourself.
This article is part of a series common topics and questions that professionals have about financing commercial solar projects. Past topics include how to price the risk of cash equity vs tax equity in a partnership flip and how to calculate the buyout process of a PPA.
This lessons will be on the most common modeling mistakes that Chris Lord see’s developers make. Chris Lord runs a consulting practice called CapIron and is a co-teacher of the Solar Executive MBA that teaches students how to finance commercial solar projects from start to finish with expert guide. You can get a $500 off the Solar MBA here.
The modeling problem has to do with properly discounting the tax benefits of a project. The result of that problem is two-fold. First, it’s an obvious beginners mistakes. If you want to look like a professional, you need to make sure that you’re not doing this. Second, if you do it improperly, it inflates project returns, which can hurt you when the investor does their due diligence.
Note: If you want to see what Chris is doing, click on the FULL SCREEN button on the bottom right of the video. You can also download the tool Chris is using by entering your email at the bottom of the article.
We all know the importance of understanding and modeling the economics of a solar project, but what is the most common and easily corrected modeling mistake you see Developers make?
Failing to properly discount the federal tax benefits in a transaction, particularly the ITC. Most show the ITC as a direct and immediate reduction of the Capital Cost of a Project. In effect, developer is asking the tax investor to buy the tax credit by paying $1 for every $1 dollar of tax credit. Developers want to pay a discount. Sometimes the discount is expressed as a price per dollar, but the best way to account for the cost is show the purchase price paid in year zero and the ITC recovered in year 1. This ensures that the ITC will be discounted at least one year by the Investor’s discount rate.
How would you handle depreciation?
Answer: You take the available depreciation for each year – let’s say that is the excess depreciation beyond what is needed to shelter the project’s current income – calculate the value of that depreciation as the amount of tax savings that such excess depreciation will generate. For example, if you had in year 2 $110 of depreciation and $10 of project income, you would have $100 of excess depreciation. For an investor with enough other qualifying income to use that $100 of excess depreciation, the value is equal to the applicable tax rate times $100. At a 35% federal tax rate, that would mean $35 of value in year 2. Discount that back to year 0 to determine today’s value of that $100 of excess depreciation in year 2.
To learn more about solar PPAs, consider enrolling in our free course: Commercial Solar PPAs 101