Project IRR Vs. Equity IRR
January 19, 2013 Leave a comment
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 debtservice payments are kept out.
As a separate exercise, debtservice payments are introduced in the calculations and IRR is reworked. Since the cash flows after debtservice payments belong to equity shareholders, this reworked 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 company’s credit rating, it will be possible to borrow money for the project at 12% p.a., payable annually.
PROJECT IRR  Rs. Lakhs  
Year 0  Year 1  Year 2  Year 3  Year 4  
Initial Investment 
600 

Operating Cash flow 
100 
130 
169 
220 

Growth 
30% 
30% 
30% 

Salvage Value 
300 

Total 
600 
100 
130 
169 
520 
IRR 
14.6% 
EQITY IRR  Rs. Lakhs  
Year 0  Year 1  Year 2  Year 3  Year 4  
Cost of the Project 
600 

Loan Mobilised 
400 

Equity Invested 
200 

Operating Cash flow 
100 
130 
169 
220 

Growth 
30% 
30% 
30% 

Loan Repayment  
Principle Repaid 
100 
100 
100 
100 

Interest 
48 
36 
24 
12 

Salvage Value 
300 

Total 
200 
48 
6 
45 
408 
IRR 
17.03% 