The project has one operating cash flow, regardless of how it's financed. Debt lets equity holders control a large asset with less of their own money, and — as long as the project's return exceeds the loan's interest rate — the leftover profit after debt service is spread over a smaller equity base, lifting the equity IRR above the project IRR.
- Project IRR — the discount rate that makes NPV of the whole unlevered project cash flow zero.
- Equity IRR — the discount rate that makes NPV of (equity outflow, then dividends after debt service) zero. Rises with debt fraction while DSCR stays healthy.
- DSCR (debt service coverage ratio) — the safety margin lenders require. Push debt too high or the tariff too low and DSCR drops under 1.2×, then under 1.0× (the project can't even make its loan payment) — the amplification turns into risk of default, not free return.
NPV = Σ CF_t / (1+r)^t
IRR: rate r where NPV(r) = 0
Equity CF_t = Op.CF_t − Debt service_t