Adding Leverage = Higher IRR / Lower EM?
Someone help my dumbass ... but how does adding leverage (80% LTC / 12.50% rate) make my IRR increase but EM decrease?
I thought these two metrics usually move in tandem.
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Your EM decreases because you pay for more debt, hence it lowers your profit. But your IRR increases because of positive leverage.
What
Is the decrease in equity required larger than your increase in interest, loan fees, and other debt-related costs?
Assuming the same time horizon and interest cost they should move in tandem unless the marginal cost of the additional dollars is higher than the IRR (I believe there are a few inflection points where it'll still raise your IRR but lower EM). Did you increase rate as you increased the LTC? Calculate the marginal interest rate the additional leverage is earning and I'm guessing it'll be above your IRR. I played around with it in excel between a 60% and 80% leveraged deal (excuse the formatting) and you can see that the IRR went down, but the EM went up. I can probably find a time horizon/inflection point that it does the opposite.
Interest Rate EM IRR 14% -100 10 10 10 10 10 10 150 5% 60 -3 -3 -3 -3 -3 -3 -63 2.23 24% -40 7 7 7 7 7 7 87 Interest Rate EM IRR 14% -100 10 10 10 10 10 10 150 11% 80 -8.8 -8.8 -8.8 -8.8 -8.8 -8.8 -88.8 2.42 21% -20 1.2 1.2 1.2 1.2 1.2 1.2 61.2Thank you kind sir. Now could you explain it this concept to an 80IQ?
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