SolarCity Corp (NASDAQ:SCTY)’s shares have been on a roller coaster this year. The stock reached a high of $86 on February, but fell as low as $46 ahead of its first quarter results, and then jumped more than 12% after impressive quarterly results and raised outlook. SolarCity doesn’t generate profits, so analysts and investors consider the “retained value” to put a valuation on the stock. But valuing the San Mateo-based company is quite difficult as debate heats up around the underlying assumption, says Liam Denning of The Wall Street Journal.

SolarCity SCTY

SolarCity currently valued at 3.7 time retained value

SolarCity Corp (NASDAQ:SCTY) leases panels where customers sign a long-term contract to purchase electricity at a lower price. The company raises funds from third-parties and utilizes federal tax incentives to cover the panel installation costs. SolarCity pays off the third-party investors in the early years of the project, and begins reaping profits only in later years.

However, the premise behind the retained value method, as Denning puts it, is “a black box of assumptions.” SolarCity Corp (NASDAQ:SCTY)’s retained value per watt in the latest quarter came in at $1.56, adding up to a total of $1.29 billion. The Elon Musk-backed company’s current market cap of $4.8 billion put its valuation at 3.7 times its retained value. But in late February, this multiple was well above 7 times. The company aims to install more than 2,000MW of panels by the end of 2015.

Liam Denning says a big concern is that the retained value figures indicate blue-sky thinking. For instance, it assumes that over 90% of customers will extend their 20-year leases for another 10 years. That extra decade matters because SolarCity Corp (NASDAQ:SCTY) estimates that cash flows in that 10-year period will be about 29% of the retained value.

The assumption of 90% customers renewing their leases is questionable. Over the last 10 years, the solar industry has undergone massive transformation. And SolarCity Corp (NASDAQ:SCTY) has been in the market for just 8 years. Nobody can accurately predict what is going to happen in terms of technology, electricity pricing and backlash from utilities in the next 20 years. Assuming the renewal rate of 66%, the project’s value will slide by 10%. And it also prices in a 6% discount rate.

10% discount rate more realistic for SolarCity

SolarCity Corp (NASDAQ:SCTY)’s discount rate seems to be extremely aggressive. The recent securitization deals were priced at yields below 5%. Risk in the solar industry should subside as it becomes more established. The company’s 6% discount rate is just 2.5% above the 30-year Treasury bonds. That’s a razor-thin risk premium for a company that depends heavily on solar-friendly subsidies and regulations, and aims to revolutionize the electricity consumption.

Denning believes a 10% discount rate is more realistic because it better reflects the competitive and operating risks and the time horizon. Third-party investors that provide funds for installation can push for a return of 9% or more. Using a 10% discount reduces the project’s net preset value by more than 50%. Therefore, the company’s market value is likely to be a much higher multiple of retained value than the current 3.7.

SolarCity Corp (NASDAQ:SCTY) shares inched up 1.10% to $52.61 in pre-market trading Monday.