# Q&A: Alternative formula for compound degradation

*Hello there, *

*My understanding of degradation is that the first year we operate at 100% capacity and then we loose each year the percentage capacity that is in cell F10. If this is correct i came up with another formula: *

*J12*(1-(J11-1)*$F$10) *

*So this basically is the time flag multiplied by 100% - (the year operating-1)*degradation. *

*In first year we have 100%-(1-1)0,05%=100% Year 2 100%-(2-1)*0,05%=99,50% and on *

*Is this correct or not ? At the end i have a slight difference in electricity revenue, mine are at 370 419 000. *

*Othman*

Hi Othman,

Thanks for this. Always good to test things out for yourself and make sure you're happy with how the formula is working. With your formula, you are deducting a constant amount each year. i.e. performance is reducing at a steady rate of 0.05% per annum. In the formula I've used, performance is reducing by 0.5% of the previous period's performance. This means that over time, my formula will give a slightly higher level of performance than yours since the amount of the reduction is decreasing over time. This is due to my calculation taking 0.5% of a smaller number each time. Does that make sense?

See this chart comparing the results over time. My formula is the red line, yours is the blue - and I've extended the time period to show the difference better:

The formula I've used is labelled "Compound degradation" to make it clear that this is a "compounding" rather than linear effect.

Hope this helps!

Best

Kenny

## Comments

Sign in or become a Financial Modelling Handbook member to join the conversation.

Just enter your email below to get a log in link.