Reading 49: Private Equity Valuation-LOS f 习题精选

Since carried interest is paid on a deal-by-deal basis, profits are not netted. Also, carried interest is only paid if the investment’s IRR at least meets the hurdle rate of 10%.

(All figures are in $ million):
The initial allocation between the firms was:
Deutsch: (0.60)($250) = $150
Reiner: (0.40)($250) = $100

The IRRs for the two firms are:
IRRDeutsch: PV = -$150; FV = $195, N = 3; CPT I/Y → IRR = 9.14%.
IRRReiner: PV = -$100; FV = $135; N = 3; CPT I/Y → IRR = 10.52%.

Since the return on Deutsch fell short of the 10% hurdle rate, the general partner only receives profits after Reiner. The profit is 20% of $35 million, or $7 million.

Statement 3 is correct. One way to visualize the IRR method is to think of the venture capital method using NPV in reverse. With the IRR method, the investor’s present investment is compounded at the IRR rate over t (number of years to exit) to arrive at the investor’s expected future wealth.

Statement 4 is also correct. Private equity firms frequently use the free cash flow or a sales or earnings multiple approach to project terminal values. Debt (both junior and senior) is factored into these calculations.

For answers to questions 3-5, refer to the following table:

Management fees are 1.50% of cumulative called down capital (paid-in capital).

NAV before distributions for any year is the NAV after distributions of the prior year, plus new capital called down, plus operating results, less management fees.

Carried interest is discussed below.

NAV after distributions for any year is NAV before distributions less carried interest less any distributions. (Study Session 13, LOS 47.j,n)

2007 management fees are calculated as 1.50% of paid-in capital. 2007 paid-in capital is $200 + $100 + $100 + $50 = $450. Management fees are 1.50% of $450, or $6.75.

Carried interest is the general partner’s share of fund profits. It is calculated based on the total return (NAV before distributions) method using committed capital. Total capital commitment by investors is $500 million. In 2007 NAV before distributions was $529.8, exceeding committed capital for the first time.

Carried interest is 25% of NAV before distributions less committed capital, or (0.25)($529.8 ? $500) = $7.45. (Study Session 13, LOS 47.f,i)

Carried interest is paid to the general partners based on the total return method using committed capital. Carried interest will thus be only paid when total return (as measured by NAV before distributions) exceeds the committed capital of $500 million. The first year that carried interest would be paid is 2007. (Study Session 13, LOS 47.f,i)

DPI measures the limited partners’ (LPs’) realized return in the fund. DPI is calculated as the cumulative distributions divided by the paid-in capital. Cumulative distributions for 2008 were $150 + $100 + $70 = $320. Paid-in capital in 2008 was $200 + $100 + $100 + $50 + $50 = $500.

The ratio of cumulative distributions to paid-in capital is $320/$500 = 0.64

RVPI measures the LPs’ unrealized return in the fund. It is calculated by dividing the NAV after distributions by the paid-in capital. NAV after distributions in 2008 was $518.5.

The ratio of NAV after distributions to paid-in capital is $518.5/$500 = 1.037 (Study Session 13, LOS 47.h,i)

The venture capital firm's discount rate adjusted for the probability of failure is calculated as follows:

The LBO company's equity beta is calculated based on the following formula:

(Study Session 13, LOS 47.k,o)

Distribution waterfall identifies the profit allocation between LPs and GPs and specifies when GPs can receive carried interest. Ratchet refers to the equity allocation between shareholders and management. Carried interest is the GP’s share in fund profits.

Limited partners’ liability does not extend beyond their capital investment, whereas general partners (the fund managers) have unlimited liability for the firm’s debt. The general partner’s share in fund profits is referred to as carried interest. Management fees are paid annually as a percentage of capital (NAV, paid-in-capital, or committed capital) and are not tied to fund profits.

A clawback provision in a private equity prospectus requires the general partner to repay part of previously distributed profits if the fund subsequently underperforms.

Since carried interest is paid on a total return basis using committed capital, the general partner of RDO would only receive interest when the portfolio value exceeds committed capital ($50 million). First-year profit is $5 million, bringing the portfolio value to $35 million, therefore no carried interest is paid. Since no profit was distributed to the general partner in the first year, a clawback does not apply in the second year.