Project IRR Vs

Project IRR Vs. EquityIRR

A good principle to follow is to separate the project decision from the financing decision i.e.the project should be viable on a standalone basis, independent of the financing mix.

Therefore, initially IRR is determined at the project level, without considering cash flows related to financing. In this computation of project IRR, interest and debt-service payments are kept out.

As a separate exercise, debt-service payments are introduced in the calculations and IRR is re-worked. Since the cash flows after debt-service payments belong to equity shareholders, this re-worked IRR is essentially the return on equity invested in the project i.e.Equity IRR.Suppose that a project entails an investment of Rs. 600 crore. It is expected to generating operating cash flow of Rs. 100 crore in Year 1, going up by 30% each year for the following 3 years. At the end of Year 4, the project will have a salvage value of Rs. 300 crore. It is proposed to finance the project with a 2:1 debtequity ratio. Given the companys credit rating, it will be possible to borrow money for the project at 12% p.a., payable annually.

PROJECT IRRRs. Lakhs

Year 0Year 1Year 2Year 3Year 4

Initial Investment-600

Operating Cash flow100130169220

Growth30%30%30%

Salvage Value300

Total-600100130169520

IRR14.6%

EQITY IRRRs. Lakhs

Year 0Year 1Year 2Year 3Year 4

Cost of the Project-600

Loan Mobilised400

Equity Invested-200

Operating Cash flow100130169220

Growth30%30%30%

Loan Repayment

Principle Repaid-100-100-100-100

Interest-48-36-24-12

Salvage Value300

Total-200-48-645408

IRR17.03%