Understanding LCOE and Solar Payback

Levelised Cost of Energy is the constant price per kWh at which the project's discounted revenues exactly cover its discounted lifetime costs. It answers one question: what does a unit of electricity from this asset cost to produce?

LCOE = Σ [(CapEx + OpEx_t) ÷ (1+r)^t] ÷ Σ [E_t ÷ (1+r)^t], where r is the discount rate, E_t is the energy produced in year t, and both numerator and denominator are discounted. Failing to discount the energy term is the single most common mistake and understates LCOE by 20–30%.

Capital cost per kWp, annual specific yield, discount rate and system lifetime drive almost all of the variance. O&M is usually 1–1.5% of CapEx per year for rooftop and slightly less for utility-scale.

Degradation compounds: 0.55%/year over 25 years removes about 13% of the final-year output, and roughly 7% of lifetime energy.

Simple payback = net CapEx ÷ annual savings. It is easy to explain and systematically optimistic because it ignores the time value of money, tariff escalation and degradation.

Discounted payback recomputes the same crossover using discounted cash flows and typically lands 1–2 years later. Quote both, and label which is which.

ROI over the asset life = (total savings − total cost) ÷ total cost × 100. NPV is the discounted surplus in currency terms; IRR is the discount rate at which NPV equals zero.

For comparing a solar investment with other uses of the same capital, IRR versus your hurdle rate is the decisive number — LCOE compares generation options, not investments.

A 10 kWp rooftop system at ₹45,000/kWp costs ₹450,000. At 1500 kWh/kWp/year it yields 15,000 kWh in year one. With a ₹8/kWh tariff, first-year savings are ₹120,000, giving a simple payback of 3.75 years.

Over 25 years at 0.55% degradation, 1.2% O&M and a 7% discount rate, lifetime discounted energy is roughly 166,000 kWh and discounted cost roughly ₹560,000 — an LCOE near ₹3.4/kWh, comfortably below the retail tariff.