Calculating Returns

Question 1

IRR

Answer 1

• Internal rate of return
• Its the non-discounted, annualized rate of return on invested equity over the lifetime of a deal
• Metric investors use to measure the attractiveness of a potential LBO, as well as the performance of their existing investments
• IRR measures the total return on a sponsor’s equity investment, including any additional equity contributions made, or dividends received, during the invesment horizon
• Factors in the time value of money – for a given amount of cash proceeds at exist, a shorter exit timeline produces higher IRR for the PE firm. If the investment takes longer to realize, the IRR will decrease

Question 2

Primary IRR drivers

Answer 2

• Target’s projected financial performance
• Purchase price
• Financing structure ( the size of the equity contribution)
• Exit multiple
• Exit year

Question 3

Formula for IRR with a single return cash flow is

Answer 3

(cash returned/ cash invested)^ (1/ # years before return realized) - 1
For example, suppose a PE firm invested 1 million in a deal and realized a return of 3 million after five years. Its IRR would be (3/1)^(⅕) -1 = 24.6%
IRR depends not only how much total profit a deal generated but also how long it takes to realize these profits. IRR goes down the longer it takes to exit the deal
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Question 4

MoM

Answer 4

Sum of all net returns/ cash invested
Multiple of money return
It’s the sum of all the net projected projected returns expected to be received over the term of the deal over the amount of equity the PE firm invested to acquire the company