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
what is the general formula for cash on cash return?
total operating cash distributions DIVIDED by average invested capital
what is the calculation for average invested capital?
opening invested capital at cost plus time weighted average contributions made by investors in the year, LESS time weighted average distributions received by investors in the year
what is cash yield and why is it important in private equity?
cash yield provides information on the ratio of total cash distributions received, irrespective of whether these distributions are operating or capital in nature, to the average MV of the investment
it is important because oftentimes, cash is left in the investee company to operate and pay down debt, and cash yield includes exit proceeds to account for a liquidity event, rather than just distributions out
what is the actual formula for cash yield?
total cash distributions (operating and capital) divided by average MV
what is the formula of average MV of the investment?
opening MV of investment
PLUS
TWA contributions made by investor in the year
LESS TWA distributions received by investors in year
what is All in Return?
a measure used to evaluate the efficiency of an investment or portfolio compared to other investments, portfolios etc
what is the formula for all in return?
total market value net income (total op cash plus total net income)
DIVIDED BY
average MV of investment
ALSO is
operating cash return plus gross MV investment income return = all in return
why is operating cash return only useful for investments into infrastructure?
because it only accounts for cash distributions from the investment, not any operating cash that is left in the operating company (like a PE investment would be in)
what is the formula for operating cash return?
total operating cash distribution received
divided by
average MV of investment
