Project Management

EIRR vs FIRR in Project Appraisal

EIRR (Economic Internal Rate of Return) and FIRR (Financial Internal Rate of Return) are both discount rates at which the net present value of a project becomes zero, but they are computed from two different points of view and therefore answer two different questions.

1. Point of view (whose costs and benefits)

• FIRR is calculated from the viewpoint of the project owner/investor (e.g., Nepal Telecom as an enterprise). It considers only the cash flows that actually enter or leave the firm's books.
• EIRR is calculated from the viewpoint of the whole economy/society (the nation). It considers all gains and losses to society, whether or not they pass through the firm's accounts.

2. Nature of costs and benefits

• FIRR uses financial (market) prices — actual prices paid and received, inclusive of taxes, duties, subsidies and interest.
• EIRR uses economic (shadow) prices — market prices adjusted for transfer payments and distortions. Taxes, duties and subsidies are excluded (they are transfers within society), and shadow wage rates, shadow exchange rates and shadow prices of traded goods are used.

3. Treatment of externalities

• FIRR ignores external effects (positive or negative) such as reduced road congestion, pollution, time savings of users, or benefits to other sectors.
• EIRR explicitly includes such externalities and indirect benefits/costs to the economy.

4. Treatment of financing

• FIRR is affected by the financing mix — debt, equity, interest paid and repayment of loans are all included in the cash flow.
• EIRR is independent of financing; interest and loan repayments are pure transfers within the economy and are excluded. EIRR measures the project's contribution to national income, not to the investor's profit.

5. Decision criterion and use

• FIRR is compared with the firm's cost of capital / hurdle rate (or lending rate) to judge commercial viability and bankability.
• EIRR is compared with the social discount rate / opportunity cost of capital of the country (often taken around 10–12% in Nepal) to judge whether the project deserves national resources. A project may have a low or even negative FIRR but a high EIRR (typical of rural telecom or road projects), and vice versa.

In short: FIRR answers "Is this project profitable for the enterprise?" while EIRR answers "Is this project worthwhile for the country?" A project is finally acceptable only when it is viable on both counts — FIRR ≥ cost of capital and EIRR ≥ social discount rate.