Certified Energy Auditor Certification Economic Analysis and Financing 5 — Questions and Answers
Question 1: A commercial building owner is evaluating an LED lighting retrofit. The owner's cost of capital is 8% and the project's IRR is 11%. What conclusion can be drawn?
- The project should be rejected because IRR exceeds the cost of capital
- The project adds value because IRR exceeds the minimum required return (Correct answer)
- The project is borderline and requires further sensitivity analysis only
- The project should be deferred until energy prices rise above 11%
Correct answer: The project adds value because IRR exceeds the minimum required return
When IRR exceeds the cost of capital (hurdle rate), the project generates returns above the minimum threshold and creates economic value.
Question 2: What is the purpose of sensitivity analysis in energy project economic evaluation?
- To calculate the exact payback period under guaranteed conditions
- To assess how changes in key assumptions affect project outcomes (Correct answer)
- To determine the minimum contract length for an ESPC
- To verify that energy savings meet measurement and verification protocols
Correct answer: To assess how changes in key assumptions affect project outcomes
Sensitivity analysis tests how variations in inputs like energy prices, discount rates, or savings magnitude affect metrics like NPV or IRR.
Question 3: Which of the following best describes a 'shared savings' Energy Savings Performance Contract?
- The building owner and ESCO split the energy savings according to a predetermined ratio (Correct answer)
- The ESCO takes 100% of savings until the project is paid off, then transfers savings to the owner
- The utility and building owner share responsibility for funding the retrofit
- The government subsidizes 50% of verified savings through a grant program
Correct answer: The building owner and ESCO split the energy savings according to a predetermined ratio
In a shared savings ESPC, the building owner and ESCO split the verified energy cost savings according to a negotiated percentage split throughout the contract term.
Question 4: How does inflation generally affect the real value of fixed annual energy savings over the life of a project?
- Inflation increases the real value of fixed nominal savings
- Inflation decreases the real purchasing power of fixed nominal savings (Correct answer)
- Inflation has no effect on energy savings because energy is a physical commodity
- Inflation increases savings value only if the discount rate is below CPI
Correct answer: Inflation decreases the real purchasing power of fixed nominal savings
If energy savings are fixed in nominal terms, inflation erodes their real purchasing power over time, reducing the real economic benefit.
Question 5: An auditor calculates the adjusted internal rate of return (AIRR) rather than the standard IRR for a project. What problem does AIRR solve that IRR cannot?
- AIRR accounts for project risk by adjusting the discount rate
- AIRR eliminates the issue of multiple IRR solutions in non-conventional cash flow streams (Correct answer)
- AIRR incorporates utility rebates that standard IRR ignores
- AIRR adjusts for currency fluctuations in international projects
Correct answer: AIRR eliminates the issue of multiple IRR solutions in non-conventional cash flow streams
Projects with non-conventional cash flows (multiple sign changes) can yield multiple IRRs; AIRR resolves this by using a single reinvestment rate assumption.
Question 6: A municipality wants to finance energy upgrades using a tax-exempt bond. What is the primary benefit of tax-exempt financing for energy projects?
- The municipality avoids all M&V requirements under the bond covenants
- Interest paid on the bonds is exempt from federal income tax, allowing lower interest rates (Correct answer)
- Tax-exempt bonds are not subject to competitive bidding requirements
- Bondholders assume all project performance risk in exchange for tax benefits
Correct answer: Interest paid on the bonds is exempt from federal income tax, allowing lower interest rates
Tax-exempt municipal bonds carry lower interest rates because investors accept a lower yield in exchange for the federal tax exemption on interest income.
Question 7: When calculating the net present value of an energy retrofit, which of the following represents a 'residual value' consideration at the end of the analysis period?
- The cost of the initial energy audit
- The remaining economic value of equipment that outlasts the study period (Correct answer)
- The total energy savings accumulated over the project life
- The annual maintenance cost in the final year
Correct answer: The remaining economic value of equipment that outlasts the study period
Residual (salvage) value represents the remaining worth of equipment at the end of the analysis period and is included as a positive cash flow in LCC calculations.
Certified Energy Auditor Certification Economic Analysis and Financing 5
A commercial building owner is evaluating an LED lighting retrofit.
The owner's cost of capital is 8% and the project's IRR is 11%.
What conclusion can be drawn?