CEM Finance, Budgeting, and Contracts 3 — Questions and Answers
Question 1: An energy manager is comparing two projects. Project A has an IRR of 14% and Project B has an IRR of 11%. The company's hurdle rate is 12%. Which project(s) should be approved?
- Only Project A (Correct answer)
- Only Project B
- Both Project A and Project B
- Neither project
Correct answer: Only Project A
Projects are acceptable when their IRR exceeds the hurdle rate; Project A (14% > 12%) qualifies, but Project B (11% < 12%) does not.
Question 2: In a shared-savings ESPC arrangement, how are the energy cost savings typically split between the owner and the ESCO?
- The ESCO receives 100% until the project is paid off, then 0%
- Savings are split by a pre-negotiated percentage throughout the contract term (Correct answer)
- The owner receives 100% and pays the ESCO a fixed fee
- Savings are deposited into an escrow account and distributed annually
Correct answer: Savings are split by a pre-negotiated percentage throughout the contract term
In a shared-savings ESPC, the owner and ESCO divide energy cost savings by a pre-agreed percentage (e.g., 60/40) for the duration of the contract.
Question 3: Which financial metric is most appropriate for ranking multiple independent energy projects when capital is limited?
- Net Present Value
- Simple Payback Period
- Profitability Index (Correct answer)
- Debt Service Coverage Ratio
Correct answer: Profitability Index
The Profitability Index (NPV divided by initial investment) ranks projects by value created per dollar invested, making it ideal for capital rationing decisions.
Question 4: A utility tariff includes a ratchet clause set at 85% of the previous 11 months' peak demand. If the highest recorded peak was 1,000 kW and the current month's actual peak is 700 kW, what demand is billed?
- 700 kW
- 800 kW
- 850 kW (Correct answer)
- 1,000 kW
Correct answer: 850 kW
The ratchet demand = 85% × 1,000 kW = 850 kW, which exceeds the actual 700 kW, so the facility is billed for 850 kW.
Question 5: Which type of contract clause protects an energy buyer from unexpected fuel price increases by allowing cost adjustments tied to a published index?
- Force majeure clause
- Escalation clause (Correct answer)
- Liquidated damages clause
- Termination for convenience clause
Correct answer: Escalation clause
An escalation clause links contract prices to a recognized index (such as the CPI or a fuel price index), automatically adjusting costs when the index changes.
Question 6: What is the primary purpose of a measurement and verification (M&V) protocol in an energy performance contract?
- To estimate future energy prices
- To verify that guaranteed savings have actually been achieved (Correct answer)
- To negotiate the interest rate on project financing
- To determine the equipment depreciation schedule
Correct answer: To verify that guaranteed savings have actually been achieved
M&V protocols provide an objective, agreed-upon methodology to confirm that projected energy savings were actually realized during the contract period.
Question 7: An energy project costs $200,000 and is expected to save $35,000 per year. Using the simple payback method, approximately how many years will it take to recover the investment?
- 4.3 years
- 5.7 years (Correct answer)
- 6.7 years
- 8.2 years
Correct answer: 5.7 years
Simple payback = Initial cost ÷ Annual savings = $200,000 ÷ $35,000 ≈ 5.7 years.
CEM Finance, Budgeting, and Contracts 3
An energy manager is comparing two projects.
Project A has an IRR of 14% and Project B has an IRR of 11%.
The company's hurdle rate is 12%.
Which project(s) should be approved?