Calculate Cash Payback On Home Improvements
June 2, 2008 – 6:35 amI was vaguely listening to an episode of Suze Orman while working on this site over the holiday, and I heard a question and answer that seemed crazy to me.
I was listening to a caller that asked if they could afford to buy solar panels for their home. The cost was $20,000, and the person was going to finance the purchased on a home equity line of credit. Suze went through the persons financials and decided that the person could afford the purchase. Whatever. I’m not sure I agreed, but then again it’s their life.
My issue was the cost to be “green”. I can understand people choosing to live green and do what is right regardless of the cost, but I found it odd that an outspoken financial talk show host failed to note that this investment would probably never pay back! The caller mentioned that the solar panels would reduce their utility bill by 85%, and that their monthly bill was about $120/month.
In a case like this you need to look at the “cash payback” for the investment. Companies review their investments (capital expense reviews) using a variety of financial metrics, one of which the cash payback metric. Larger firms use discounted cash flow models, but you don’t need to use a method that is complicated. As a first step you should look at the cash payback, which is the number of years it will take for an investment to pay itself back. Don’t worry about inflation, opportunity costs, etc. Simply calculate the cash payback by taking the investment amount and divide it by the savings (or income) per year to figure out how many years it will take to pay for itself.
Let’s take a look at the cash payback for this example.
Assuming $5,000 was used as a down payment, at a savings of 85% of $120 = $102 per month it would take 12.25 years to pay off the purchase if NO INTEREST was charged on the HELOC. If the HELOC has an interest rate of 5% it would take about 20 years to pay itself back. If the interest rate is close to 10% the investment would never pay for itself, because the interest on the loan would be more than the yearly savings.
Clearly this approach won’t work for all “investments”. For example, clearly some purchases aren’t designed to pay themselves back or earn an income. I seriously doubt you’ll get all of your investment back by upgrading your home by installing new counter tops for example. Even if you do, it’s unlikely that this type of investment will pay itself back before you sell your home. Some investments, like those intended to reduce your on-going expenses, should be reviewed based on cash payback. Upgrades like solar panels or radiation barriers for windows (if you live in the south) come to mind. These situations should pay themselves back over a reasonable amount of time. I’ll leave it up to you to decide what “reasonable” means. 
| 2.5 |
If You Liked This Post Then Please Check These Out...
|
1 Trackback(s)