Contribution to IRR
Hi guys, I am wondering if someone could help with IRR contribution. For example, I have a stream of Cash flows that gives me an IRR of say 10%. If I then decompose those cash flows into different categories (say 3) I will get an IRR for 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
You would carve up the purchase price by the three separate cash flow streams and calculate independent IRRs. The weighted average IRR will get you to the global IRR, 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 and amounts of CapEx, and I want to know how each different category of CapEx contributes to changes in my IRR vs business case.
The point of an IRR is 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 an IRR breakdown: 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 different IRR contributions?
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 my IRR. I do not seek to make them equal. I just want to show which one affects the most the IRR. 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. Your IRR would be like 12%. Then hold exit multiple at your entry multiple, then change revenue growth in your model. IRR would 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 total IRR. Basically, I would like to reproduce this kind of chart https://opinionatedthought.wordpress.com/2015/08/17/breaking-down-the-i…
but cannot download the spread sheet to see the method...
I am not trying to change my IRR, 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 total IRR. 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.
IRR is (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
IRR should be 48%, with no distributions/contributions to equity in interim years. If you multiply together CAGR of Revenue, EBITDA margin, and EBITDA multiple you will get IRR, 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 an IRR, but as far as I know, there's no clean way to break out a % for it.
Long story short, IRR measures 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 total IRR ties to your fund's IRR, and (probably) highlight revenue growth and operational improvements as a return driver as much as you can.
Similique sed omnis odit et numquam. Voluptatem optio a consectetur omnis deserunt. Error rerum incidunt tempora ut. Voluptatem commodi necessitatibus error eveniet.
Voluptatem voluptatum autem quia possimus consequatur dolor quibusdam. Saepe voluptas tempore unde doloremque ea officia incidunt.
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...