Calculating IRR & CoC with no equity contribution
Running a model that is entirely financed by debt (Construction loan, Perm loan, TIF, DDF). Is it possible to run IRR & CoC returns without any equity contributions coming into the project? Should I add $1 in Owner's Equity to solve this?
If you have no equity contribution, you have no capital base, thus no return "on" capital calculations will make much sense. You could take all future cashflows and discount back for net present value (or really just a present value as you are subtracting zero from PV). Still, exactly what does that mean?
If the firm/investor has to hold back a certain amount of cash in escrow/bank for reserves (can be a condition of such debt), or is otherwise restricted somehow on other investments, you could use that amount as the imputed capital contribution. Just be sure to also add any interest earned as savings to the mix.
But really, if truly a zero investment deal, those return on capital invested calcs won't make sense. You can add the $1 and get an answer, but might as well just write "infinity" because that is the mathematical approximation you are reaching.
So then what "return" metrics would be appropriate to look at for this type of deal? If you use PV, how do you benchmark that?
Well, if you are truly without capital at risk, then "return" is not a meaningful concept. It's more like services revenue tbh. The question to ask is what is foregone if you do this deal? Does mean you can't accept another one? Is the firm investing monies for overhead/salaries/office space etc? (that could be basis for investment capital, if meaningful). It's all about relative measurement, so what's the alternative?
As for the PV or essentially the valuation of the deal, you could compare that to other deals/projects NPVs, those would be comparable. But again, only meaningful if the deal precludes the ability to do others. Which when getting debt or even equity investments, is often the case (not to mention people constraints).
If the firm has some contingent risk in default (which I'd assume the case), you can weigh the risk of loss vs. the level of profits and then make a judgment call. Note, don't put the contingent risk $$$ in as an initial investment, can seem tempting, as you will get a more normalized number, but it really is an irrelevant comparison, as in the downside you likely get just the bad outcome.
I mean, lots of crazy options value theory could be applied, but again, what are you actually trying to solve for?
Ratione quos consequuntur quaerat aut exercitationem. Accusantium nostrum voluptas totam a dignissimos eveniet. Ad nobis est veritatis earum.
Dolorem nihil dolore omnis omnis nam eos. Vero quia blanditiis voluptatem consectetur non possimus. Culpa ad saepe nihil accusantium vitae non omnis rem.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...