Ungeared vs geared IRR
Is the geared IRR typically higher than the ungeared IRR of a company? In what scenarios would it not be the case?
Trending Content
Career Resources
WSO Free Modeling Series - Now Open Through
May 31, 2024
9 Free Financial Modeling Lessons
Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
+Bonus: Get 27 financial modeling templates in swipe file
+Bonus: Get 27 financial modeling templates in swipe file
Referring to leverage as gear from now on thx
Man, I would hope so. Leveraged IRR should be higher than unleveraged, unless ... the cost of debt was higher than the cost of equity? I don't know when that would ever be the case.
Just remember leverage amplifies returns. Here's a simple example:
Example A: 100% Equity
Pre-debt service cash flow: 50
Equity: 100
Return: 50%
Example B: 50/50 Debt and Equity
Pre-debt service cash flow: 50
Debt service: -10 (assuming 5 year am. excl. interest)
Post-debt service cash flow: 40
Equity: 50
Return: 80%
mathematically, back of envelope gives:
Levered IRR=unlevered IRR + (unlevered IRR - cost of financing) * (leverage to cap)/(1-leverage to cap)
the ratio is non-negative. in order for levered IRR to be less, you’d need cost of financing to exceed the unlevered IRR.
theoretically financing decisions do not affect value of company excluding tax shielding and bankruptcy costs.
however, more practically the effects of leverage may affect business value (thru future cash flow strain) in certain ways.
anyhow, levering equity that yields lower return....this is just unusual though
it should basically never be, as debt is cheaper than equity. However, your question may be going past me. What do you mean? Can you add context?
Leverage is used judiciously to boost returns nowadays so this really wouldn't apply--- maybe the company would take on too much debt, go into bankruptcy, and idk while less leverage would have allowed the company to survive and improve cash flows to equity (blah blah blah, u know what I mean here)
Doloremque quia quia sequi quis sit repellat reiciendis. Eaque doloremque doloribus qui minus ipsa doloremque sapiente cupiditate.
Sequi aut et odio tempora velit ex. Vero totam error quasi ducimus. Qui unde rerum ex sit adipisci ipsum. Nihil sed consequatur dignissimos aut nihil nihil.
Quidem est et molestiae et voluptas sint et. Illum et a autem qui sed. Ipsum molestiae id officiis quos voluptatem accusamus. Beatae laboriosam distinctio optio ducimus cumque ea sed. Ratione animi dolorum ipsam.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...