During an LBO, assets can be written up (including intangibles). This influences the amount of goodwill that is created.
I am wondering if the amount of these write-ups affect the IRR. My thinking is that it will not affect the returns, because the asset write-ups are accompanied by an appropriate deferred tax liability so there won't be any change in cash flows. If some goodwill is allocated to intangibles, again my thinking is that it will not affect the returns since this allocation never changes bottom line cash flow (assuming zero amortization).
Can anyone confirm or help my thinking? How do these asset write-ups and allocations of goodwill affect IRR in reality?
pretty sure you only count realized gains or return on investment when doing irr calculations. unrealized gains such as write-ups can impact unrealized quarter end valuation but not irr as far as ik
Interesting question, I think it can affect cash flows and therefore IRR. If you think about it - you write up PPE and there will also be an associated depreciation expense with that. Like you said it will depend on the DTL that gets created, but if the yearly depreciation is higher than DTL it will create a tax shield, so you get more of a break off that. It will add to your cash available for debt repayment, which will increase your IRR. Really depends on amounts of depreciation and DTL though.
I'm no expert and just spitballing here, but that's prob what I would say in an interview.
Goodwill is not an intangible asset. It's literally a fucking thrift store
Right, but in an LBO, you will generally allocate a portion of it to PPE write-ups, hence the depreciation
True. But you forgot about FASB's income tax provision, which allows for PP&E to be written down when goodwill impairment exceeds the annual amount of intangibles, net of tax.
The DTL amortization will exactly offset the effects of the tax shield created for the PPE step up. The reason that step up is created is that in most acquisition structures, you are not allowed to step up the tax basis of the assets.
I believe that step up decisions will not have an impact on cash flows as the tax code does not recognize the step ups. Happy to hear anyone’s thoughts otherwise though.
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