Table of Contents
Introduction
Economic and financial feasibility analysis answers a simple question: is a renewable energy project financially worthwhile and economically sound for those who invest in it and for the wider society that hosts it. For beginners, this chapter focuses on how to judge whether a project is likely to attract finance, pay back its costs, and survive in real market conditions. Other chapters address detailed cost concepts and financing models, so here the focus remains on how these pieces come together in a feasibility assessment.
From Technical Potential To Bankable Project
A technically feasible project is not automatically financeable. Economic and financial feasibility sits between technical design and real-world implementation. Once resource availability, technology choice, and approximate system size are known, the next question is whether the expected revenues or savings can cover all costs with an acceptable level of risk.
Bankability is the term often used to describe whether a project is attractive to lenders and investors. A bankable renewable project typically has credible cost estimates, predictable cash flows based on realistic assumptions, clear ownership and contracts, and risks that are identified and managed. Economic and financial feasibility analysis is the process used to show this bankability in a structured and quantitative way.
Identifying Costs And Revenues
The starting point of any feasibility analysis is a careful list of expected costs and revenues over the lifetime of the project. Capital expenditure covers all up-front investments such as equipment, installation, grid connection, and development costs. Operating expenditure covers regular costs such as maintenance, insurance, land leases, and sometimes fuel for bioenergy or biomass projects.
On the revenue side, grid-connected electricity projects usually earn income by selling energy to a utility or market at a tariff or market price. Some projects may receive additional payments through policy mechanisms such as premiums or renewable obligations. Behind-the-meter projects, for example a rooftop solar system on a factory, often create value by reducing the amount of electricity purchased from the grid and sometimes by exporting surplus energy. For these projects, the main economic benefit is avoided cost rather than direct revenue.
Time Value Of Money And Discounting
Financial feasibility requires taking into account that a dollar today is worth more than a dollar in the future. This principle is called the time value of money and it is handled by discounting future cash flows back to their value today.
The basic formula for the present value of a future cash amount $C\_t$ received in year $t$ with discount rate $r$ is
$$
PV = \frac{C\_t}{(1 + r)^t}.
$$
The discount rate reflects the opportunity cost of capital and the risk of the project. A higher discount rate reduces the present value of future benefits and makes long-lived projects appear less attractive. In renewable energy, which often has high up-front cost and long lifetimes, the choice of discount rate has a strong influence on economic and financial feasibility.
Key rule: Always compare costs and benefits as present values using a consistent discount rate, otherwise feasibility conclusions can be misleading.
Net Present Value, Payback, And Internal Rate Of Return
Several indicators are commonly used to judge financial feasibility. Each looks at the project from a slightly different angle, and basic feasibility assessments often use more than one.
Net present value, or NPV, adds up the present value of all projected cash inflows and subtracts the present value of all cash outflows, including the initial investment. It can be expressed as
$$
NPV = \sum\_{t=0}^{T} \frac{CF\_t}{(1 + r)^t},
$$
where $CF\_t$ is the net cash flow in year $t$, $T$ is the project lifetime, and $r$ is the discount rate.
Decision rule: A project is financially acceptable if $NPV > 0$ at the chosen discount rate, and among alternatives, the one with the highest positive NPV is preferred.
The simple payback period measures how many years it takes for cumulative net cash flows to recover the initial investment. It is easy to understand but ignores cash flows after the payback point and does not account properly for the time value of money.
Internal rate of return, or IRR, is the discount rate that makes the NPV exactly zero. It solves the equation
$$
0 = \sum\_{t=0}^{T} \frac{CF\_t}{(1 + IRR)^t}.
$$
Investors often compare the IRR of a project to a required minimum return. If the IRR is higher than this hurdle rate, the project is considered attractive. IRR is intuitive because it expresses profit in percentage terms, but it can be misleading when cash flows are irregular or when comparing projects of very different scale.
Cash Flow Modelling Over The Project Life
To calculate NPV, IRR, and payback, an analyst builds a cash flow model that covers the entire expected life of the project. For a renewable plant, this typically involves a large negative cash flow in year zero for construction, followed by annual operating costs, debt service payments if the project is financed with loans, and annual revenues or savings.
Renewable energy output usually declines slightly over time, for example solar panel output may degrade each year. Operation and maintenance might rise as equipment ages. Policies may also change the revenue per unit of energy, such as fixed feed-in tariffs that are guaranteed for a defined period, or market prices that can fluctuate year by year. A feasibility model recognizes these patterns and incorporates them in the assumptions.
Economic Feasibility Versus Financial Feasibility
Financial feasibility focuses on the perspective of the project developer, lender, or investor, and looks at real cash flows, taxes, loan conditions, and required returns. Economic feasibility is broader and considers the net benefits to society as a whole. It often includes costs and benefits that do not show up directly in the project accounts, such as environmental damages avoided, public health benefits from reduced air pollution, or impacts on employment.
In economic analysis, prices may be adjusted to reflect social values instead of market distortions, and external costs or benefits may be added. For renewable energy, economic feasibility can be strong even if pure financial returns are modest, especially where renewables reduce imported fuel dependence or avoid severe local pollution. Governments sometimes use this type of analysis to justify public support or policy incentives for renewable projects.
Revenue Certainty And Policy Frameworks
The stability and predictability of revenues are central to financial feasibility. Projects with long term power purchase agreements, guaranteed tariffs, or capacity payments typically appear safer to lenders than projects that sell into volatile spot markets. The length of contracts can also determine the term of available loans, which then influences annual debt payments and overall project viability.
Policy instruments strongly shape feasibility. Auctions, feed-in schemes, or renewable portfolio standards create different patterns of risk and reward. A bankable revenue framework usually has clear rules, limited political uncertainty during the contract period, and transparent pricing mechanisms. When policies are weak or unpredictable, even technically and economically attractive renewable projects may fail financial feasibility tests.
Financing Structure And Cost Of Capital
How a project is financed influences its feasibility. A high share of debt can reduce the overall cost of capital compared to pure equity finance, but it also requires regular loan repayments, which can stress cash flows in early years. The weighted average cost of capital, often abbreviated as WACC, combines the required returns of equity and the interest on debt in proportion to their shares in the capital structure.
Lower WACC improves NPV and makes long life, capital intensive projects like wind, solar, or hydropower more attractive. Public guarantees, concessional loans, or blended finance can reduce the effective cost of capital for renewable energy in markets where private financing is expensive. In economic and financial feasibility studies, assumptions about interest rates, debt share, and investor return expectations are therefore highly influential.
Risk Analysis And Sensitivity Testing
No feasibility study can perfectly predict the future. Energy prices, technology performance, exchange rates, and policy conditions can all change. Robust feasibility analysis therefore includes sensitivity testing, where key variables are varied to see how much they affect NPV, IRR, or payback period.
Examples include testing what happens if investment costs are higher than expected, if annual energy output is lower due to poorer resource conditions, or if tariffs are reduced. If small changes in one parameter cause the project to become unviable, the project is considered highly sensitive and risky from a financial perspective. Scenarios that combine several changes, for example higher costs and lower revenues, are also used to explore worst case outcomes.
Important practice: Always test project feasibility under different assumptions for key drivers like energy price, output, and investment cost, instead of relying on a single optimistic case.
Scale, Ownership, And Local Economic Effects
Economic and financial feasibility can look very different depending on scale and ownership structure. Large utility scale projects may benefit from lower unit costs but require more complex financing and face more demanding return expectations. Small community projects may have higher unit costs but can access concessional funding or accept lower financial returns if local economic benefits are strong.
From a broader economic perspective, local job creation, reduced fuel imports, and increased energy security contribute to project desirability. Some feasibility studies explicitly consider these local benefits, especially when public or community funds are involved. Even if pure financial returns are modest, strong positive local impacts can justify moving ahead with a project.
Using Levelized Cost In Feasibility Context
The levelized cost of energy is introduced in detail elsewhere in the course, but it also plays a role in feasibility analysis. While NPV and IRR look at a particular project and its financing, the levelized cost offers a way to compare the intrinsic cost of energy from different technologies or project options over their lifetimes. In economic and financial feasibility studies, levelized cost can be compared to expected tariffs or avoided energy costs to judge whether a project is likely to remain competitive over time.
However, feasibility decisions should not rely on levelized cost alone. Cash flow timing, financing conditions, taxes, and specific policy supports must be taken into account. A project with a low levelized cost may still be hard to finance if investors perceive high risks or if the revenue structure is weak.
Conclusion
Economic and financial feasibility is the bridge between a technically sound renewable energy concept and a project that can be financed and implemented. It brings together cost and revenue projections, the time value of money, risk assessment, and policy conditions to reveal whether a project is attractive for investors and beneficial for society. For beginners, the essential message is that good renewable projects are not only clean and technically possible, they must also be structured so that their lifetime benefits clearly outweigh their costs when evaluated with realistic financial tools.