The financial analysis is based on calculations of the following standard viability indicators:
• Financial Internal Rate of Return
• Internal Rate of Return on Equity
• Net Present Value of Project
• Net Present Value on Equity, after financing
• Payback Period, after tax
The FIRR and the NPV are measures of the financial feasibility of the project. The WACC is a benchmark used to evaluate the profitability of the proposed investment against alternative investment opportunities. The FIRR should be at least equal to the WACC in order for the project to be considered feasible. The WACC is estimated by summing the products of a) the equity component of the capital and the required rate of return, and b) the debt component and the interest rate of the loan. To illustrate, assume that the project has a 70-30 debt/equity ratio with an interest rate of 9 percent for the former and 15 percent of rate of return for the latter:
70% x 9% = 12.60 |
30% x 15% = +6.00 |
WACC = 10.8% |
The IRR on Equity and the NPV on Equity are of particular interest to the proponent since they are measures of the profitability of proponent's equity, which helps the proponent determine the optimum amount to borrow or invest personally. The payback period after tax helps the LGU and the proponent determine whether any tax incentives are required.