Last month, I shared my analysis on my considerations for taking advantage of the Energy Tax Credit and getting 30% off the cost of a new Central Air Unit since our house if 15 years old and we’ll eventually need one anyway. Well, there are various ways to look at large purchases like this, ranging from breakeven to “savings” to Net Present Value (NPV). NPV is my favorite method and I’ve outlined the results below.
After obtaining quotes on various models from the most reputable and widely used service in our area, I figured this one would be a no-brainer. Verbally, we were bouncing around concepts about variable frequency drives, efficiency ratings and all kinds of other engineer-jargon. I figured this thing would pay for itself within a few years and be well worth the up front investment since our current unit will die eventually anyway. However, upon reviewing the actual annual savings calculation estimates, it’s not entirely clear to me that we should jump on this tax credit opportunity and buy new equipment at this time.
The units, specs and pricing I had in mind were the following:
- 95% Gas Furnace & Performance 2-Stage A/C
- Installation of 95 percent efficient, natural gas hot air heater with 3-stage gas valve and variable speed blower
- Installation of 48,000 Btu, 17-seer, air conditioner at 4 tons with 2-stage compressor and infinity thermostat
- Installation of 48,000 BTU encased a-coil, which will be mounted directly on top of new gas heater
- Note: A rebate of $1,600.00 is available after installation (Utility and Mfg)
- PRICE $9,985.00
– With the $1500 Tax Credit and $1600 in rebates, and no taxes required, final price would have been: $6,885
Now, this is a new furnace and air unit and the pricing was comparable to or better than other local services but these guys had the best recommendation. So, I don’t question whether this was a good “deal”, but I do have doubts as to whether it’s an appropriate expenditure for our situation.
Once he came back with estimated savings, I just wasn’t that impressed:
- My annual savings were estimated to be a mere $329. On an annual base of about $2500 between gas and electric, that’s only 13% savings. I figured some nifty new unit would be saving me 20-30% with all this high efficiency and new technology.
- Using a discount rate of 6% and a 10 year model (see NPV link earlier to see how easily model in excel), this purchase was still NPV NEGATIVE to the tune of $4000. Now, that assumes our current unit lasts that long, but too complex to model probabilities of replacement in a hypothetical future.
Here are some other considerations:
- Moving or Staying? We’re not entirely sure we’re staying in this house forever – or even more than the next year or two. While the house is fine if we did stay, there’s another area we’ve considered for varying reasons from family proximity to school district. So, we’ve toyed with the prospect of moving for years, but never pulled the trigger. That being said, if the new unit was going to bring substantial savings annually and might make for a decent selling point as well, it may have made more sense.
- Opportunity Cost – Aside from the assumption I used in the NPV model of reasonably earning say, 5-6% long term with money invested in more aggressive assets, if we DO decide to move, that money would be put to much better use in being able to afford the home we want as opposed to losing a substantial amount upon resale. For instance, when you put in a new kitchen, the claim is, you’ll recoup say, 80% of that investment at sale. A new deck might be 50% and a pool is debatable (check out those comments!). Surely, a new Central Air unit doesn’t rank high on the scale of recouped investments. It’s probably up there with a roof or new windows – high cost house maintenance items that just aren’t viewed as that “sexy” at resale. Back to that opportunity cost – so if we did decide to move and our dream home was 7-8K outside our budget after I just put in this new unit, I’d be kicking myself.
- Pay Now or Pay Later – Contrary to my current direction though, is the notion that our current unit will die eventually. If it dies right after these tax incentives and manufacturer incentives evaporate, well then, I’ll feel badly. If it holds out another couple years, or especially if we move while it’s intact, great. I do have to contend with the notion that it may die next year though and in retrospect, I may have missed a decent deal.
- Are Prices Artificial? – Any time the government intervenes with artificial incentives, free market pricing goes out the window and subsidized pricing comes into play. We just saw it with the homeowner tax credit expiring and subsequent reduction of home sale prices in May (glad you didn’t rush to buy that house now?). Well, I question whether installation services and manufacturers are able to jack their pricing now because their units and installations are “in demand” and subsidized by the government, but say, next year, with no artificial incentives, the prices will just naturally come back down anyway. In many ways, these various government stimulus projects are just a money grab for particular industries and this may be no different. I just don’t have years of pricing data and trends to back up this suspicion so for now, it’s speculative. But I do question whether I’d really pay full pricing in 2011.
Decision: At this time I don’t intend on moving forward with the purchase. We have the money. And I’m all about making positive NPV investments and improvements to either our home or personal finances. But even with these seemingly enticing incentives, the purchase just doesn’t seem justified at this time.
Anyone Out There in the Same Boat?
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{ 4 comments }
Its good that you went through this exercise. People shouldn’t assume that a new high efficient system is going to justify the cost of an upgrade. Sounds like your current hardware is relatively efficient to begin with. So you don’t have a big reason to replace it. If you had a horribly inefficient old AC/furnace then updating to new efficient stuff could easily be justified. But replacing fairly new and relatively efficient system wit a newer highly efficient system isn’t necessarily justified.
Have you had a home energy audit? You might be better served with something like getting more insulation or air sealing.
We had an energy audit done and it was estimated we would save around $1700 per year in heating/cooling costs. We currently have a furnace and no A/C. New install after tax credits is around $9,900 and we only have $3000 to throw at it. We have the option for 0% financing, but I’m wearing to add more debt, even though my yearly savings would be huge. Thoughts?
Darwin's Finance Reply:
May 26th, 2010 at 10:11 pm
@Mickey, as it turns out, our existing unit was more efficient than I assumed. It’s a 90% unit, whatever that means. The newer technology can bring some benefits, but the spread on the savings isn’t what I expected.
In your case, that’s a tough one. Saving the money sounds good, but even with the 0% financing, when the period’s over you’ll be hit with higher rates inevitably. However, the interest you’d be paying may well offset the interest. Have you just considered waiting it out an extra year or two and doing the upgrades with less or no debt? Even though tax credits are gone, as I hypothesized above, free markets being what they are, the current prices may actually be somewhat bloated due to a govt subsidy and when that’s gone, prices may well decline.
The end result and decision seems justified to me, but a few questions:
1. Why are you worried about your current system failing soon? Mine is 25 yrs old and doing ok still. My sense is that the average life is longer.
2. Why are you using a 10 year calculation for the NPV? I would suggest adding a cost of writing off the current system with a 5-10 year useful life still left, then do the NPV calculation with a 20-25 year useful life of the new system.
Darwin's Finance Reply:
May 26th, 2010 at 10:14 pm
@Sanjay, 1. The useful life on these are apparently 15-20 years on the air unit and the furnace. I’ve seen the emergency installs at our neighbors and we all had the same unit installed by the same builder, so it’s only a matter of time (kind of like when your neighbors’ shingles start blowing away).
2. I usually use 10 yr NPV max to be conservative. The odds of moving or other things changing dramatically increase over time. Any benefit past the 10 years is gravy, but even in our corporate calculations, we use 5 and 10 years for pretty long-term projects. Going out too far might be painting too rosy a picture.
I did the calculations for the payout of a energy efficient A/C (>14 SEER) that qualified for the tax credit when we replaced our system two years ago. Here’s what I recall. For a net $65oo addtional cost ($8000 – $1500 tax credit) versus a very efficent A/C (12 SEER), our calculated annual savings was $200 per year. So the time to recover the additional cost of the higher efficiency A/C unit eligible for a tax credit was 32.5 years.
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