Performing IRR and a valuation of the company at the same time?
If you are performing a valuation of a company for a PE frim by using a DCF approach and they wanted to know the IRR of the company. What value would you use for an initial cash outflow for the PE firm? and if you used the valuation value (Ignoring premium) as the initial cash outflow and the projected free cash flows would be your cash inflow wouldn't that give you an IRR equal to your WACC?
Most business plans create more value in the explicit forecast than in extrapolation/terminal value. Therefore in most cases your ROIC would be slightly higher in the first years, but then you exit should actually be lower because the value is already created and less upside remains.
Think most PE firms want to see a LBO with a 25% IRR, 2.5x MM on 5y time horizon. That should be their valuation. You could then do a DCF at exit to see what the proceeds at exit would be (many PEs falsely assume that entry = exit multiple).
yeah like your DCF equity value is an output of what the company is worth. the equity purchase price in the top of the LBO model is how much you could proll get the equity. you can compare the 2 to see if you are under/over pricing the equity. IRR output would be based on the normal LBO model where you find the profroma statements for the term of sponsor ownership and your IRR is a function of sposnor equity and exit proceeds.
A new thing i like to do is use the LBO as a valuation where you create an ability to pay analysis: set up IRR theresholds and back solve for an MoC. Simple math and you find the cash in and therefore the equity purchase price you would pay under a preferrable capital strucutre
Not an expert but I think the value from DCF is your purchase price (or should guide your bids). Your exit price is an estimate based on how the PE firm thinks it can improve the various financial metrics and an exit multiple. So that exit price is different from your DCF number.
Also as mentioned in other comments, PE shops often backsolve their purchase price since they have their required IRR to achieve.
A PE firm would care about the IRR of their investment, which in simplified terms would be the cost of equity, not the WACC. When you do a typical DCF, you discount at WACC to an enterprise value, which will be funded by debt and equity. You could use the DCF to help in determining the entry multiple or entry price.
In the following years, you would need to adjust your cash flows for interest and debt repayments (which a constant WACC ignores) and determine potential exit values. In theory, a DCF at exit time could be performed to estimate exit EV, but as assumptions needed for cash flows and discount rates starting from 5 years after acquisition are hard to estimate, an exit multiple (eg. EV/EBITDA) is normally used.
At exit, a payout waterfall will show the proceeds to the PE after debt repayments. Then those proceeds are used for your IRR and MM calculations. Effectively this is an LBO model. If you do that the IRR would be different from your DCF WACC and cost of equity (ie. higher). In practice however, a lot of times you start with a target IRR, some entry+exit multiple ranges and exit probabilities and then back solve for how much you need to pay and how much debt you can take.
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