How to Calculate the Payback Period of Your New Heating or Cooling Equipment

If you need to purchase a new heating or cooling system, you may be wondering whether the typically high initial costs of energy-efficient equipment is worth the long-term savings. The best way to determine this benefit is by calculating the payback period. This is the length of time it will take for the operating cost savings realized by investing in an energy-efficient unit to cover the unit’s upfront purchase cost.

Doing the Math

The U.S. Department of Housing and Urban Development (HUD) offers a simple formula for calculating the payback period of an energy-efficient investment compared to your existing unit. Before we take a look at the formula, however, there is some data you will need to collect.

First, you’ll need the annual energy cost of the energy-efficient system you are considering. According to HUD, Energy Guide labels displayed on most new systems will help you to calculate the annual energy cost. To calculate the annual energy cost for a home, look up the energy rate in your area that is equivalent to the approximate cost of the fuel (cents per therm or kilowatt-hour). Using that information, consult the table provided on the EnergyGuide label to find the annual energy cost of using that equipment on your property.

You’ll also need your current system’s annual energy costs. If you use oil or natural gas only to heat your home, you’re in luck as you can simply add up the last year’s bills. However, if you have several systems that run on the same energy source as your heating or cooling system (i.e. electricity) talk to your utility company. They likely can estimate the percentage of your bill that comes from heating and/or cooling your home.

Now, using the data you have collected, determine your annual savings with the following formula:

Annual Savings = Annual Energy Cost of Existing Unit – Annual Energy Cost of New Unit

You’re not quite done yet. Next, you’ll need to know your “first cost,” or the incremental cost of purchasing your new, more efficient heating or cooling system. The incremental cost, HUD explains, is the difference between the cost of the efficient equipment and the cost of the inefficient equipment that would have otherwise been installed. You don’t need to include labor in this calculation, since labor will be incurred regardless of whether your equipment is upgraded or not.

Using that data, and the annual savings determined above, you can calculate your payback period with the following formula:

Payback Period = First Cost/Annual Savings

Case In Point

Here’s an example of how the payback calculation works. Let’s say your current gas furnace has died and you have to replace it one way or another. You’re considering purchasing a new, top-of- the-line gas furnace that is capable of reaching 94 percent AFUE and is priced at $1,700, without installation. Is it worth it to go with a high-efficiency unit with bells and whistles when your contractor explains that a perfectly good furnace with a 92 percent AFUE rating costs only $959?

Let’s find out.

Based on your utility’s average gas rate of $1.06 per therm, and the information on each unit’s Energy Guide label, you can project that the annual energy cost of the new, energy-efficient system will be about $535. The standard unit will cost approximately $700 each year.

Annual Savings = Annual Energy Cost of Standard Unit – Annual Energy Cost of High Efficiency Unit

Annual Savings = $700 – $535

Annual Savings = $165

Next, with simple subtraction you determine that your “first cost,” or the cost of purchasing the high efficiency furnace over the standard system is a $741 difference. Using that data, and the annual savings determined above, you can calculate your payback period:

Payback Period = First Cost /Annual Savings

Payback Period = $741/$165

Payback Period = 4.5 years

So it will take you about 4.5 years to earn in savings the upfront cost of your $1,700 furnace compared to a more cost-effective one.

Free Tools

HUD offers several examples of its formula in action to help you better understand the numbers. In addition, the Environmental Protection Agency’s Energy Star program offers life cycle cost estimate tools that provide estimates on the energy savings you might expect from investing in either an Energy Star-qualified gas residential furnace or a central air conditioner.

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