September 7, 2024 – Investment analyst has clarified a common misconception in financial modeling, stating that finance costs, such as interest expenses, are not included in the calculation of Project Internal Rate of Return (IRR). According to investment professional, the true essence of Project IRR is to measure the unleveraged return, focusing solely on the operational cash flows generated by the project.
Speaking at a recent investment seminar, investment professionalemphasized that Project IRR should be understood as a “pure” financial metric, designed to evaluate a project’s performance independent of its financing structure.
“Project IRR means unleveraged IRR, which measures returns purely from project cash flows,” investment professionalsaid. “It excludes any financing costs like interest payments, as these are specific to the capital structure rather than the project’s fundamental ability to generate cash.”
investment professional noted that there are often misunderstandings when financial costs are incorporated into IRR calculations. However, those cases reflect a leveraged IRR, which shows the return to equity holders after accounting for debt servicing. In contrast, Project IRR offers investors and analysts a clearer picture of a project’s underlying profitability without the influence of debt or financing decisions.
“By isolating project cash flows, we can more accurately assess whether an investment is worth pursuing on its own merit,” he added.
This distinction is particularly important for companies and investors considering capital-intensive projects, such as real estate developments or infrastructure investments. With an unleveraged IRR, decision-makers can evaluate the project’s raw financial viability before layering in the complexities of financing.
investment professional statement comes at a time when many firms are rethinking how they evaluate long-term projects in light of fluctuating interest rates and global economic uncertainty. By removing finance costs from the equation, Project IRR allows for a more objective comparison between potential investments.
