I think they forgot to subtract the initial management investment to get the profit before calculating the IRR?: Q: The Mnoyan fund is a leveraged buyout (LBO) fund with initial capital of $100 million, of which $90 million is provided by the LBO fund and $10 million by management. Profits between the fund and management are split 80% and 20%, respectively. The fund uses an EBIT multiple for projecting terminal value. The fund is liquidated after year 4 with an operating income of $50 million in year 4 and an EBIT multiple of 10 under the most likely scenario. The fund’s debt is worth $120 million at exit. The return at exit to management as measured by IRR is closest to: A) 40%. B) 36%. C) 66%. -------------------------------------------------------------------------------- Click for Answer and Explanation The fund’s terminal value is calculated using the EBIT multiple (all in millions): Proceeds at exit: Operating income (EBIT) × EBIT multiple = $50 × 10 = $500 Net proceeds are proceeds at exit less debt value: Proceeds at exit: $500 − $120 = $380 The fund’s share of the profit is 80%, or $304. Management receives 20% of profits, or $76. With an initial investment of $10 and a terminal value after four years of $76, the return to management is an IRR of 66%: PV = -$10; FV = $76; N = 4; CPT I/Y = 0.66 103999
I think this looks fine to me, the initial invsetment of 10 is used in computing IRR (PV is -10), initial investment does not affect the profits earned during the period. Hope this helps.
Where did you get this problem? Is this in Schweser?
yes, problem ID 103999
I got 66%, just remember you are looking at it from management’s point of view.