Module 11 Flashcards
what is the definition of IRR?
the discount rate that is required to present value an investment’s net cash flows to zero (ie. capital contributions are cash outflows and distributions to the investor are inflows - IRR is calculated as PV of ALL cash flows plus MV of investment PLUS cash invested)
what determines if an investment is favourable? (irr vs. other return rates)
if IRR is higher than other investment alternative return rates / hurdle rate
what is the difference between the benchmark rate of return and the hurdle rate?
benchmark is better for public investments, as you’d compare return to the nearest benchmark (ie. index-linked security) - hurdle rate is usually internal, is static, and is mandated in an investment agreement
what is time weighted rate of return? TWRR
TWRR is similar to IRR but it is altered to favor measures of investments in benchmark indices - as this removes the impact of cash distributions
what is the key difference between IRR and TWRR?
IRR is more useful for private investments, as it assumes control on investment and outflow of proceeds from the investment standpoint, whereas TWRR doesnt and it removes the affect of distributions
what are the two primary methods for using IRR in an investment decision to analyze pricing or value?
1 - goal-seek or back-solve the implied IRR by equating the price at which the investor is intending to bid for the investment, to the cash flow projections
2 - implying the overall valuation multiple at the price at which the investor is intending to bid and comparing it to the ranges of multiples established through the three primary valuation methodologies (DCF, market multiples either precedent or public multiples) - this is the “football field” approach
what is Multiple of Money? (MoM)
a commonly used analysis tool in private equity, MoM provides a return that can be compared across investment assets or portfolios (ie. short-medium term investments)
what are the two primary types of MoMs?
Total value to paid in (TVPI) ratio
Distributed to paid in (DPI) ratio
what is Total Value to Paid In (TVPI) ratio?
represents the total value of the fund or portfolio as a multiple of its cost basis - it is calculated by dividing the realized amount added to the net asset value of unrealized investments by the investment cost
what is Distributed to paid in (DPI) ratio?
this is calculated by dividing the cumulative cash distributions (capital and operating) by capital invested - this provides an indication of cash distributions relative to capital contributions paid into the fund or portfolio
if DPI > 1, this is breakeven. this is net of management fees and cost of carry
what is the biggest flaw in IRR analysis?
that it is inherently biased towards near-term results, and as a result, may occur in sub-optimal allocation of resources
what is the rule of thumb calculation for IRR? (2 parts)
yield to maturity + annual capital growth = IRR
what is cash on cash return ?
it is the ratio of operating cash distributions received by an investor to the total amount of cash invested
how does cash on cash return differ from IRR?
IRR depends on when exit occurs, and cash on cash does not.
how is cash on cash return generated for both private investment and infrastructure investment?
infra - operating distributions divided by invested capital
private - proceeds received on exit divided by invested capital
