UKC

I'm contemplating investing some money in a local renewable hydro energy scheme. I'd appreciate a little help in getting my head around how the figures work.

The way it's set up is that you invest a sum and they pay two components back to you - interest on your investment, and a gradual return of capital. After 20 years they aim to have returned all the capital and you'll no longer be a shareholder. The interest component is calculated as RPI plus 3% and will be paid from year 2 till year 20.

What I can't make add up is this. They say that they forecast an IRR of 5%. But they also say that they expect that £10k invested will be repaid over the 20 years as the £10k capital plus £9409 interest.

I suspect that I don't understand how to use IRR. I thought that it could be used as the effective rate of compound interest, so I worked out that £10k * 1.05^20 = £26533. Clearly wrong! The effective interest rate to make £9409 from a £10k investment over 20 years looks to be about 3.4% to me.

So, firstly, can anyone tell me what I'm doing wrong with my use of IRR?

And secondly, what do people think of this as an investment? I recognise that it's inherently risky as it's based both on what happens to RPI, and also on whether the scheme works out well enough to be able to afford to make the repayments - if it doesn't generate enough power, then I would lose first the interest and, concievably, the capital too. I'm planning to put £5k in that I can afford to lose.

I'm doing this as much because I believe in what they're trying to do, as well as in order to make some money. I could just pay off the mortgage a little, or invest elsewhere; I am reasonably risk averse and I view this scheme as not too risky.

Thanks for any thoughts.

In reply to Jamie Wakeham:

Ignoring the maths, I would look at the likely success of the hydro scheme primarily. I've known two in my old local area. One at Gayle Mill, which was part of the BBCs restoration programme roughly 8 or 9 years ago, all hot air and less on action. Numerous turbine problems, some problems with the shoot that feeds the turbine being built from the wrong wood initially etc... it generates electricity, but it was a money pit. The other an Archimedes screw at Bainbridge, all the locals who bought in are shareholders (no capital pay back) is still working well and done on budget.

I'd be more concerned if it's the right type of turbine for that location, good water flow, reasonably easy access for construction to keep costs down, is there some type of steering committee or shareholder board etc... RPI, CPI etc.. is irrelevant if it don't spin enough!

In reply to Jamie Wakeham:

I'm guessing they are using IRR as the internal rate of return, which is the discount rate required to bring net present values of the future cash flows to zero.

See www.investopedia.com/terms/i/irr.asp for some more depth.

I wouldn't worry too hard about RPI - I would worry more about the operational risk of the scheme, as it sounds like these repayments aren't legally structured like a bond, it sounds like the repayments are contingent on enough profit being generated from the scheme to do this capital repayment.

In reply to Jamie Wakeham:
Are you lending them money which they pay back like a repayment mortgage?

Repayments to you are initially mostly interest and towards the end mostly capital.

Hence £10k * 1.05^20 = £26533 is not the right calculation.

Put the figures into a mortgage calculator for comparison.

In reply to Jamie Wakeham:

Thanks, all.

Yes, the idea is that *IF* the scheme works well, then they use the profit to pay the shareholders their interest and capital back, so it's not a bond. If the screws don't generate enough power then we don't get our interest as forecast (theoretically, if they don't generate enough then we even lose the capital, but I'm not very worried about that scenario).

And yes, it's like a reverse mortgage in that at first we're being repaid mostly interest and little capital, and at the end it's mostly capital repayment.

I am reasonably confident that it's a well-run and well sited scheme; three archimedean screws on the Thames just south of Oxford. The parent company has a good record of doing well, both with large PV and a previous hydro scheme up-river at Osney. The first year's generation there was about 85% of predicted average but 2015 was an odd year; they're well ahead of average for the first half of 2016.

elsewhere: I thought the whole point of IRR was that you could use it as if it were the interest rate of an equivalent fixed rate investment? This is why I'm confused.

In reply to Jamie Wakeham:
While I was slowly typing you got far more informed responses so take this with a pinch of salt.

I can do numbers that may be wrong because I cannot do terminology like irr or bonds.

To me you have interest and repayment of capital so the mathematics is the same as a repayment mortgage.

Using the bbc mortgage calculator, £10k, 20 years, repayment mortgage, 7.5%, £81.64 pcm x 240 months is £19594.

That matches your £19409 so that is an investment with apr 7.5%.

I do not understand irr so i won't comment on that.

In reply to Jamie Wakeham:

As an investor I'd be wanting to see how the big cheeses in the company get paid - if they get paid regardless of the success of the scheme then that's pretty poor, if their success depends on the success of the scheme then I think that's a fair deal. Their experience does bode well for the success of the scheme.

In reply to Jamie Wakeham:

If it's their IRR then you've not got enough information. You would need to know the timing of their cash flows to calculate the IRR.

If its a one off payment followed by revenue then you're right, but actually given the scheme it will be a multi-year build and a ramp of payments over time.

In reply to Jamie Wakeham:

Toerag: that's a good question. A quick dig through their published accounts tells me that, last year, the seven directors were paid a total of £86k, plus various expenses and a further £45k paid to one particular director as consultancy fees. As far as I understand it, this is an umbrella company that has many schemes on the go, of which the hydro scheme I want to invest in is just one, and it doesn't look like the directors' pay is linked particularly to how one scheme does. Having said that, it also looks like none of them is getting very rich out of this.

John_Hat: I htink I'm starting to understand IRR a little better now. Thanks.

I guess a better question would have been: is an investment that will steadily return £19.4k from £10k capital over the next 20 years a good one, given the current climate? My feeling is that it's reasonable but not spectacular?

In reply to Jamie Wakeham:


3.4% is rather low for what it seems to me is a fairly high risk investment - unless of course they are guaranteeing that rate of return. I should think that there are better options, such as a standard low-risk diversified portfolio from one of the usual brokers.

In reply to planetmarshall:

Agreed. But 3.4% is wrong - it's what I naively worked out as the rate you would need to earn in a fixed rate interest account to invest £10k and have £19.4k at the end of 20 years, assuming you had to leave the capital untouched.

But this scheme pays the capital back gradually, so its equivalent rate (and I now think this is what's meant by IRR?) is 5%, which seems a bit better.

I fear I need to speak to an IFA.

In reply to Jamie Wakeham:

IRR is useful for companies if you are comparing 2 projects, but in this case it doesn't sound like a great metric for making an investment decision, especially if you aren't sure about the calc.

If you are risk adverse (i.e. you want to stay away from the stock market, which I would definitely advise!), then work a few things out:
1) what would you get if you stuck the cash in an ISA / savings bonds?
2) how much interest would you save on your mortgage if you made an early repayment (make sure to incl. fees)

Then choose the one that gives you the highest net gain. As a disclaimer, I'm not an IFA, and don't take investment advice from me!

In reply to Pewtle:

I am not an IFA either but had actually looked at investing on this, briefly. As you point out the interest is 5%, because as someone pointed out it is effectively calculated like a reverse mortgage, in that after year one you will receive a small bit of your capital back so instead of 10,000 your investmet would be say 9,500 and the interest of course would be smaller than what you would get on the 10,000 to maturity. My gut said no, but I was wary of investing for 20 years. Another way to look at this would be to compare it to investing in a property I think 5% would be a good return (assume you had no mortgage and were renting it out) and I think the principal would be more secure, but as I said I just demand a premium for a 20 year investment.

In reply to Jamie Wakeham:

Thanks, both. Mortgage is fixed for three more years at 1.9% and we've a healthy overpayment cushion. I'm happy to let that continue ticking away in the background.

I guess what I'm really trying to figure out is how much more could I make, with a similarly low level of risk, and am I prepapred to take the hit for investing in what I see as very worthy green tech.

ISAs are risk free and paying around 2%, so £10k compounded in one of those for the twenty years (if interest rates remain crappy) would give me £15k back in total if I left it all and made no withdrawals.

This hydro scheme sits in the middle of the risk spectrum - having done my research and spoken with a friend who's in the industry, I do believe it will deliver what it promises. It'll deliver £19k back for my £10k, but paying back regularly so I can re-invest that income.

Compare that to the 5 year rate at a P2P site like Ratesetter - probably the same level of risk as the hydro scheme - it's paying 6%, so in 20 years I would end up with £32k, but again that'd have to be locked away.

What I lack is the ability to compare those last two options, because I don't know how to value the fact that the hydro scheme is giving me money back to use or reinvest right from the start. But I think I can take the 5% IRR that's quoted and use that to compare directly to the 6% of the P2P investment. So I conclude that the latter is 17% better than the former?

And then, if that's right, I have to consider if I want to make an investment that is 17% worse than what I could get, but makes a better societal contribution by generating green electricity. Probably yes.