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Energy-efficient design of battery-powered systems demands optimizations in both hardware and software. We present a modular approach for enhancing instruction level simulators with cycle-accurate simulation of energy dissipation in embedded systems. Our methodology has tightly coupled component models thus making our approach more accurate. Performance and energy computed by our simulator are within a 5% tolerance of hardware measurements on the SmartBadge. We show how the simulation methodology can be used for hardware design exploration aimed at enhancing the SmartBadge with real-time MPEG video feature. In addition, we present a profiler that relates energy consumption to the source code. Using the profiler we can quickly and easily redesign the MP3 audio decoder software to run in real time on the SmartBadge with low energy consumption. Performance increase of 92% and energy consumption decrease of 77% over the original executable specification have been achieved.