geothermal power plant projects in central america - Orkustofnun

cost of investment. The net present value formula for an investment that generates cash flow C in thefuture period is = (1 + ) (49)The basic investment rule can be generalized thus:• Accept a project if the NPV is greater than zero• Reject a project if NPV is less than zeroThe numerator of Equation 49 is usually understood as being the expected time cash flow, and thediscount rate in the denominator.The calculation of the net present value (NPV) requires a value for the discount rate and its selectionis the main difficulty for this method. Crundwell (2008) argued that the discount rate value selection isessentially a strategic function and is done from the viewpoint of the entire organization; and the valueof the discount rate that is used can be the financial cost of capital, the economic cost of capital or therisk adjusted discount rate.Internal Rate of Return (IRR)According to Benninga (2008) the internal rate of return (IRR) is defined as the compound rate ofreturn that makes the NPV equal to zero, which is expressed as (1 + ∗ ) = 0 (50)The general investment rule is clear:• Accept the project if the IRR is greater than the MARR.• Reject the project if the IRR is less than the MARR.The IRR is about as close as you can get to NPV without essentially being NPV. Hillier et al. (2010)argued that “the basis rationale behind the IRR method is that it offers a single number summarizingthe merits of a project. That number does not depend on the interest rate prevailing in the capitalmarket”. This is why it is called the internal rate of return: the number is internally intrinsic to theproject and independent except for the cash flow of the project. In this analysis, to evaluate capitalexpenditures the IRR is calculated on both project and equity.Minimum Acceptable Rate of Return (MARR)According to Hillier et al. (2010) the discount rate on a risky project is the return that one can lookforward to earning on a financial asset of equivalent risk, often referred to as an opportunity costbecause corporate investment in the project takes away the shareholder's opportunity to invest thedividend in a financial asset. Crundwell (2008) indicated that the opportunity cost of capital is thereturn on the most profitable project that is not accepted; this is the Minimum Attractive Rate ofReturn (MARR). The opportunity cost of capital and MARR are terms that mean the same thing.The MARR for both project and equity needs to be determined by the project owners. Björnsdóttir(2010) pointed out that the MARR for a project is frequently the rate of return of the most preferablealternative investment, and the MARR for equity is usually the same as the investor’s cost of capital.Therefore, the lowest acceptable limit for IRR should be greater than MARR. In Section 6.3.7, theselection of a discount rate is discussed.42