Let's take a look at the returns to the creditors rather than shareholders.

In this case. Again, the investment in the project is the investment during the construction period. And remember, there may be fees involved and they need to be baked into the calculation because the fees may well go to the institution, which is arranging the loan. For example, if it is a syndicated loan, the arrangement fees need to be taken off the initial investment because there are cash inflows to the lenders.

Now, after the construction phase, during the operational phase, we'll have the principle and interest being paid to the lender. Then you can calculate the internal rate of return with the cash out during construction and the cash in during the operational phase. Remember, arrangement fees need to be baked in because they will typically go to the lender. And also if there is accrued interest, that's not being paid in cash. It needs to be baked in and be put into the cashflow profile on a cash basis. In other words, when you receive the accrued interest in cash, not when you expense it. Again, just like in the equity situation, you would compare the internal rate of return to the cost of funding. However, it's not completely straightforward. Let's take a look at three types of loans with the same IRR. The first loan that we've got here is a bullet repayment loan due in the year 10 with a 5% interest and an internal rate of return of 5%.

The second loan is what we call a PIK interest loan. In other words, the interest is not being paid in cash. It's rolled up onto the balance. So you can see the ending balance increasing over the 10 year period. But the IRR is still 5%. And lastly, we have a loan with a staggered repayment pattern. In this case, you can see you're getting 5% interest, but you are getting your capital repaid over six years. In all three cases, the internal rate of return is exactly the same. So the question is, which loan is better? Well, it depends on how quickly you get your cash flow back. And in this situation, the third loan pays back your cash earlier. So it is the best followed by the first loan because you're getting cash interest. And then the very last loan is the pick interest loan because you have to wait until year 10 to get any cash at all.

So this is the drawback of the internal rate of return. It doesn't tell you how quickly you'll get your cash back.