The calculation of the shareholder IRR in the context of a cross-border investment differs from the calculation of the IRR of the local project. It is not based solely on local operating performance, but on the actual cash flows exchanged between the parent company and its foreign subsidiary, after currency conversion.

Here is the detailed methodology for making this calculation:

1. Identify capital flows (Inputs and Returns)

The shareholder IRR is calculated from the sequence of “Contributions / Returns” funds from the point of view of the investor (the parent company).

• Contributions (Negative Flows): These are the funds sent by the parent company to finance the project. They include the initial equity investment and any subsequent capital increases necessary to maintain the target financial structure or cover start-up losses.
• Returns (Positive Flows): These are the funds that the project sends back to the shareholder when it has cash in excess of its operating and debt repayment needs. They take the form of dividends, capital reductions or repayments of shareholders’ current accounts.

2. Converting currencies (The impact of differential inflation)

This is the critical stage. The project’s flows are generated in local currency (e.g. Indian rupee), but the shareholder reasons in his own currency (e.g. Euro). To convert the projected future flows, it is recommended to use the Purchasing Power Parity (PPP) Theory.

• The principle: The exchange rate between two currencies evolves according to the inflation differential between the two countries.
• The rule: If local inflation is higher than the inflation of the shareholder’s country, the local currency will devalue.
• Example: For a project in India (inflation 6%) with a European investor (inflation 2.5%), the Indian Rupee (INR) is expected to devalue by about 3.5% per year against the Euro.

3. Calculating the IRR

Once the flows have been converted into the shareholder’s currency, the IRR of this sequence of flows is calculated (the discount rate that cancels out the NPV of the converted contributions and returns).

Result: The shareholder IRR will be different from the IRR of the local project.

4. Interpretation: Comparison with the Profitability Requirement

To determine whether this investment creates shareholder value, this IRR calculated must be compared to the Group’s return on equity requirement (ROE). For an international project, this requirement is calculated by adding three components:

1. The risk-free rate of the shareholder’s country.
2. The classic risk premium (Beta × Equity Market Risk Premium project).
3. A Country Risk Premium: This corresponds to the specific risk of the host country (instability, political risk) and can be estimated via the CDS  (Credit Default Swaps) rate of that country’s sovereign debt.

If the calculated shareholder IRR is higher than this overall requirement, then investing abroad creates value for the Group.