Own capital IRR

Replies to This Discussion

Permalink Reply by Dipu James on January 30, 2010 at 1:24am

Own capital IRR is simply the WACC (cost of capital) of the company....
ie the cost to the company to pay its debt and the equity.

if the project irr is more than this that means you have crossed the hurdle if not even though the project is profitable it will not fit into your WACC.

▶ Reply to This

Permalink Reply by Brent Wheeler on February 1, 2010 at 5:14am

I think the concept your Board is referring to you is the cost of capital faced by your company as measured by IRR (as per Dipu's response). It is unfortunately the wrong hurdle rate for a project since a project must be able to cover the cost of capital of the project - it is the risks inherent in the project (and it's cashflows) which are the ones which must be covered if the project is to be worthwhile.

Imagine a water utility with a cost of capital of 6% deciding to build Concorde - a project which has a risk of say 25%. The fact that the company's cost of capital is only 6% is of no relevance whatsoever!

It is a common notion however!!!!!

▶ Reply to This

Permalink Reply by Alex WANG on February 1, 2010 at 10:07am

Thank you, Dipu and Brent.
Currently, we calculate the own capital IRR like this:-
1.calculate the project's yearly free cash flow, incl.cash flow from operations, financing and investment.
2. compare the equity injected by the investment company (own capital) with the free cash flow of each year to get the IRR
Financial gearing is therefore taken into account in own capital IRR calculation, which is not the case in project IRR.
Best regards,
Alex

▶ Reply to This