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What is the meaning of this line: the higher the project IRR over the proposed loan interest rate, the lower the risk of default.
“Providers of finance may wish to know the project’s internal rate of return (IRR). In particular, banks compare project IRR to the interest rate on proposed loans in order to measure the “headroom” on the project and the consequential risk of default on the debt: the higher the project IRR over the proposed loan interest rate, the lower the risk of default.”
It means that if the internal rate of return (IRR) of a project is significantly higher than the interest rate on the loan being considered to finance the project, there is a greater margin for error…
This “headroom” indicates that the project is generating returns well above the cost of borrowing, which reduces the likelihood that the project will fail to generate enough cash flow to cover the loan repayments, thereby lowering the risk of default.
In simple terms the higher the IRR (breakeven NPV) then it means the risk of non repayment of the loan is low.
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