What is ‘Usual Practice’ for Calculating Project NPV?

I was asked by a client recently for guidance on the ‘usual practice’ for calculating project NPV. I had to think a bit about it but here are my thoughts on the matter.

Precise definition of Project NPV

There are many definitions for calculating project NPV. I’ve seen a lot of project finance models from the audit perspective at PKF and Corality and also from the sponsor perspective working as part of the Bouygues consortium and in practice, there is no one method consistently used.

There are advantages and disadvantages to most methods however the most important thing is to ensure consistency when comparing projects.

Project NPV- 4 key considerations

There are 4 key considerations to be defined when calculating project NPV, all of which should be clearly stated when quoting a project return.

• The reference date it is measured at
• Geared or Non-geared
• Pre-tax v Post-tax
• Real or Nominal

The “True” Method of calculating project NPV

For a true evaluation of the project that completely ignores debt, the precise method is to calculate the NPV based on nominal non-geared cashflows with the pre/post tax position clearly stated.

This is usually more of an exercise as it involves removing debt costs from construction (interest and all other financing costs) and recalculating tax based on no debt interest or financing related payments (line fees, financing fees etc).

A geared project return does not imply the inclusion of funding / repayment, just the inherent associated financing fees and is often a shortcut as it is readily calculated - we see this a lot.

Be consistent when calculating project NPV

The key point to note however is that whichever measure you use, you must be consistent.

Even if you are comparing a 20-year Aluminium refinery project in Mozambique with a new 30-year toll road concession in Australia, the only useful comparison is where the two projects are assessed using the exact same method.

For further guidance on NPV calculations, Navigator have a useful article on calculating NPV using excel. If you want a further challenge, why not check out our article on how to calculate NPV without excel formulae as well.

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