There are two kinds of projects out there: non-mutually exclusive projects and mutually exclusive projects. Mutually exclusive projects are the ones where a building system is removed and a single system replaces it. Let’s say you’re evaluating three different replacements that have a best, better and good selection to choose from. You have nine choices in all. Ultimately, you have to remove one piece of equipment (or system) and install a replacement. In such a situation, you need to choose the equipment with the best life-cycle cost, which is not necessarily the choice with the lowest first cost.
Non-mutually exclusive projects are a bit trickier. Let’s say you go into a building and say, “We could replace the HVAC, controls, or lighting, or perhaps add window films, solar panels and so on.” You don't necessarily have to do the solar if you do the lighting and vice versa. This makes proposing improvements to a prospect an entirely different ballgame.
When you do non-mutually exclusive projects there are four rules:
1) You want to consider lowest life-cycle cost alternatives. For example, if you are thinking of replacing the boiler, that becomes one of perhaps many ways to invest your capital. You want to make sure that it's the lowest life-cycle cost boiler in case you select it as one of the upgrades you elect to fund.
2) You want to eliminate alternatives with negative net present value. Net present value is basically how many dollars you have left after earning your discount rate on the dollars you invest. Most people don’t want to invest in things that will leave them with less money at the end of the project than they had when they started once all cash flows are discounted back to their present value.
3) Keep in mind that there are certain exceptions to #2. For example, let's say a school system has a boiler fail. They have to replace it, and it’s going to have a negative net present value because it's a capital replacement. It's being replaced to restore a key aspect of the building’s functionality, not to save energy.
4) You have to calculate each potential project’s modified internal rate of return (MIRR) or savings investment ratio (SIR). Modified internal rate of return is the MIRR function within Excel. Savings-to-investment ratio is a formula in which the present value of everything you receive over the course of the analysis term is divided by the present value of everything you invest in that same period. It is a present value version of “bang for your buck.”
Once you’ve figured things out, fund the investments in order of descending MIRR or SIR. This makes sense because if you have 10 things you could invest in, you'd probably want to do the project that would give you $4 back for every dollar you invest before you do one that would give you $1.50 back for every dollar you invest.
You often have to choose what are the highest priorities because the building owner doesn't have enough money to do everything. If you follow these guidelines, you’ll be in an excellent position to justify your recommendations.