IRR Analysis - Calculating the IRR Levered
In most cases, investors will want to calculate how much return their investment is expected to make and compare it with other alternative investment options. As such, conducting an IRR analysis is critical to determine if the investment is profitable or not. By simply calculating the IRR or also known as the internal rate of return, the investor will get an insight and evaluate any new investment proposition considering their merits and risks.
As you already know, the IRR is calculated based on projected free cash flows to which the IRR is equal to the discount rate that leads to a zero Net Present Value or NPV of the said cash flows. But of course, you must first determine what kind of free cash flows to use such as the following:
1. Levered Free Cash Flows – also known as free cash flows to equity shareholders calculated as: Unlevered Free Cash Flows + Change in Financial Debt – interest + correction for effective taxes paid.
2. Unlevered Free Cash Flows – also known as the free cash flows to firm calculated as: EBIT x (1-tax rate) – CAPEX + Add back Depreciation – Changed in Net Working Capital
Where:
EBIT = Earnings before Interest and Taxes
CAPEX = Capital Expenditures
As you can see, to be able to calculate the IRR Levered, it is important to calculate the IRR Unlevered first. This means that by adhering to this rule, you can ensure that the risks of the investment projects are considered before deciding on selecting the investment venture or projects.
However, it is not always that conducting an IRR Analysis is effective for every venture especially for investments that generates interim cash flows. As such, you can use other financial ratios instead to calculate for the financial feasibility and profitability of the investment. Basically, the IRR is best suited for analyzing venture capital and private equity investments.
To read more about the differences between the IRR Levered and IRR Unlevered, feel free to read the article: IRR Levered vs IRR Unlevered. You can also download financial model templates with calculations of IRR to use as a reference once you build your own financial model and calculate for the IRR levered and unlevered. You can get even more templates at eFinancialModels, platform offering a wide range of industry-specific financial model templates made by experts that have substantial financial modeling experience and industry know-how, so you don’t have to hire a professional to build a fully customized model for you.
As you already know, the IRR is calculated based on projected free cash flows to which the IRR is equal to the discount rate that leads to a zero Net Present Value or NPV of the said cash flows. But of course, you must first determine what kind of free cash flows to use such as the following:
1. Levered Free Cash Flows – also known as free cash flows to equity shareholders calculated as: Unlevered Free Cash Flows + Change in Financial Debt – interest + correction for effective taxes paid.
2. Unlevered Free Cash Flows – also known as the free cash flows to firm calculated as: EBIT x (1-tax rate) – CAPEX + Add back Depreciation – Changed in Net Working Capital
Where:
EBIT = Earnings before Interest and Taxes
CAPEX = Capital Expenditures
As you can see, to be able to calculate the IRR Levered, it is important to calculate the IRR Unlevered first. This means that by adhering to this rule, you can ensure that the risks of the investment projects are considered before deciding on selecting the investment venture or projects.
However, it is not always that conducting an IRR Analysis is effective for every venture especially for investments that generates interim cash flows. As such, you can use other financial ratios instead to calculate for the financial feasibility and profitability of the investment. Basically, the IRR is best suited for analyzing venture capital and private equity investments.
To read more about the differences between the IRR Levered and IRR Unlevered, feel free to read the article: IRR Levered vs IRR Unlevered. You can also download financial model templates with calculations of IRR to use as a reference once you build your own financial model and calculate for the IRR levered and unlevered. You can get even more templates at eFinancialModels, platform offering a wide range of industry-specific financial model templates made by experts that have substantial financial modeling experience and industry know-how, so you don’t have to hire a professional to build a fully customized model for you.
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