Contribution to IRR
Hi guys, I am wondering if someone could help withIRRcontribution. For example, I have a stream of Cash flows that gives me anIRRof say 10%. If I then decompose those cash flows into different categories (say 3) I will get anIRRfor every category and can´t to much with those. Now, if I want to find the contributionof each of those 3 categories to my 10% "global"IRR, how can I do it? I remember that I have to convert each stream of cash flows to make it comparable, but that is about it. Can anyone help?
Thanks in advance
Comments (10)
You would carve up the purchase price by the three separate cash flow streams and calculate independent IRRs. The weighted averageIRRwill get you to the globalIRR, where the weights are determined by the segmented purchase prices.
What you're doing, to be clear, isn't a particularly helpful exercise by the way.
Thank you. Why isn´t helpful? I am comparing the business case of a proyect with its updated cash flows, namely differences in timing andamounts of CapEx, and I want to know how each different category of CapEx contributes to changes in myIRRvs business case.
The point of anIRRis to understand and to decompose market expectations built into a bona fide purchase price. Here, the segmented prices are synthetic, an estimate. In other words, you're estimating the information that you're looking for.
I may be misinterpreting the exercise you're trying to do. If so, you can ignore this comment.
I am looking for the same thing. I want to show anIRRbreakdown: how do you calculate how much come from multiple arbitrage, revenue growth, profitability improvement and cash accumulation ?
I want to show the results on a waterfall chart with the differentIRRcontributions?
Thanks!
When you're modeling each, can hold all other factors equal, no?
Hum. This is not the point I think. I just want to show the different sensitivities / highest contribution factors to myIRR. I do not seek to make them equal. I just want to show which one affects the most theIRR. It is really a common practice in Private Equity...?
Yea, I know.....I'm saying, for example, you can hold revenue growth at 0%, and change the exit multiple assumption. YourIRRwould be like 12%. Then hold exit multiple at your entry multiple, then change revenue growth in your model.IRRwould be like 8%. Make sense?
Thank you, I get your points. "you should notice that each of the 4 component parts, when taken individually, actually do not sum to the total IRR" this is interesting.
Actually my question is more simple: it is how do you produce the chart which shows the different contributions? I tried to put CAGR from revenues, profitability, multiples expansion, leverage but this does not equal my totalIRR. Basically, I would like to reproduce this kind of chart https://opinionatedthought.wordpress.com/2015/08/17/breaking-down-the-irr/
but cannot download the spread sheet to see the method...
I am not trying to change myIRR, I just want to show a good waterfall contribution summary chart which can be flexible.
Thank you!
I don't follow that website's derivation of its formula, especially after the writer starts dividing by 1+CAGR(Equity).
During my time in banking, I worked in an industry group, and we would just have a plug for the last piece of the chart to tie to totalIRR. Perhaps the people who work at fund of funds and/or fund management have a more rigorous understanding of how to "properly" show this breakdown.
IRRis (for the most part) multiplicative. I believe that trying to break that down in a way that sums up component returns is pretty analysis but mathematically flawed. Revenue growth, margin expansion, and multiple paid all scale up/down a business - they multiply, not add.
Try this exercise below in excel to better understand where I'm coming from.
Year 1
Year 5
IRRshould be 48%, with no distributions/contributions to equity in interim years. If you multiply together CAGR of Revenue,EBITDAmargin, andEBITDAmultiple you will getIRR, after subtracting 1 from the result. It's neat how that ties out, but this is an oversimplified version of the analysis. If, for instance, you have equity distributions or contributions during the interim period or any debt paydown, this will add or subtract a dollar value to your total return. You'll still have anIRR, but as far as I know, there's no clean way to break out a % for it.
Long story short,IRRmeasures how big and how quickly future cash flows arrive. Future cash flows are influenced by corporate finance decisions, market valuations, and improvements in business operations, all of which should be intertwined and considered as a whole. Make the chart for your boss and make sure totalIRRties to your fund'sIRR, and (probably) highlight revenue growth and operational improvements as a return driver as much as you can.
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