When delving into discussions surrounding renewable energy projects, the inevitable question of returns often takes center stage. Investors seek clarity, asking sellers for a straightforward answer: “What is the return for the project?” Yet, the response, often a seemingly simple percentage, may not tell the full story.
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Why financial returns can deceive
What many fail to realize is that the calculation of returns in renewable energy investments is far from straightforward. Two parties evaluating the same project may arrive at vastly different figures for returns. Why? The devil lies in the details of the assumptions underlying these calculations and the diverse interpretations of the term “return.”
A case study on renewable energy project returns
Consider a hypothetical scenario involving a wind turbine project. Here, we examine two common metrics for assessing returns:
Return on Investment (ROI): Calculated as EBITDA divided by total investment.
Internal Rate of Return (IRR): Utilized to assess the present value estimate of future cash flows.
Let’s crunch the numbers based on a wind turbine project with the following attributes:
- EBITDA: €2 M
- Total Investment: €25 M
- Equity: €25 M (100%)
Understanding the discrepancies
In our analysis, the ROI is computed as 8%, while the IRR, accounting for the project’s NPV, yields a return of 5.8%. However, if we introduce debt financing, with equity reduced to €5 M, the IRR spikes to 11%.
Embracing the nuances of return assessment
It’s clear that the choice of return metric significantly impacts the perceived profitability of the project. Yet, all these figures represent pre-tax numbers, potentially offering tax advantages to buyers. Thus, for the same project, returns can fluctuate from 5.8% to 8% to 11%, depending on the chosen definition of “return.”
