How to calculate IRR in head?
How should you approach calculating IRR in your head using figures?
In an interview I was asked something along the lines of: if you acquire a company for $100m using 30% equity and 70% debt and exit in 5 years for $200m assuming no debt repaid / the capital structure remains the same (30%/70%) what would be your IRR?
Then they asked follow up questions such as what if the exit was $300m? Or what if it was 7 years? Or if you paid down debt over the years and your exit structure was 50% equity and 50% debt etc..
It wasn’t word for word like the above - I can’t remember the exact info given / details of the questions but it was something along the lines of this.
I was struggling a lot in calculating it mentally but would appreciated how the correct way to approach the mental math would be!
Thanks
Figure out the MoM then you can get IRR. For a 5 year investment, you can roughly "move the decimal place over and subtract 5%".
For example: 2.5x = ~20% IRR, 3.0x = ~25%
EDIT: I'm seeing a lot of incorrect math below so let me caveat the above by saying this "trick" really only works for MoM returns of 2.0x - 4.0x over a 5 year period, which is where most PE returns lie so it's useful for quick IRR approximations.
Remember that the relationship between IRR and MoM is expontential (IRR = MoM^(1/t) - 1), so you can't just subtract 5% from any MoM (e.g. 7.5x MoM is roughly 50% IRR).
Thanks, I assume because it’s based on the MoM multiple it doesn’t matter / make a difference from what the leverage of the investment is?
And for different years e.g if you had a 3.0x MoM After 8 years would it be 30-8 so approximately 22% etc?
Thanks
It does, in your example, you invest 100m at a e/d split of 30/70. So you have 70 of debt. When you exit for 200m at the same split, you do have 70 of debt and hence 130 of equity or a 4.33x Money Multiple. Assuming this was a 5 year investment you get to an IRR of roughly 36%
Also remember the rule of 72...
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