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Project finance decision criterion
Equity NPV or Equity IRR,Which one is best in project finance ?
Replies (2)
NPV is better and more conservative approch. because IRR assumes that even intermediate cash flows are RE-INVESTED at IRR rate. this assumption may not always stand true. you may face investment risk over passage of time and in this case realised IRR and expected IRR could be different.
In my view,Equity IRR is best .In project finance,we use cost of equity valuation approach.Cost of equity will vary every year as the firm's debt ratio is very high in the beginning and is close to yearby the end of 12-15 ,when entire loan will be paid off.High usage of leverage leads to heavy cash flows .And IRR favour those projects which have got heavy cash flows in early period.If Equity IRR is greater than required rate of return(determined by market ie.competitor business)during all the years ,then the project is positive NPV to the sponsors.
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