Private equity preferred return (hurdle rate)

CFA Level II
#1

Given PE company X at time 0, X = 100 at time 3 (exit), X = 135 (net of fees) preferred return is 10%. Carry is 20%. How much does the GP make? The IRR is 10.52%, above the hurdle, so there is some amount of carry. Here is my question. Is the carry the full 20% of the profit, or is it that portion above a 10% Net IRR? Stated differently, is it: A: .2 * 35 = 7 (this is how Schweser solved it) or, B: 35 - [profits required to ensure LPs have 10% IRR, or about 33.1] = 1.9 (what I expected) or, is it only 20% of the amount above the preferred return, .2 * 1.9? (what I saw on random website X) I could swear that the most common terms you find in PPMs are in the form of B, but I’m not sure what CFA expects. Maybe I should read the books :s ----thanks

#2

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#3

There is such a thing as a soft hurdle (A) and a hard hurdle (B). I think CFAI will take the simple general approach unless stated as a hard hurdle. If the GP can meet the set hurdle rate, s/he is entitled to 20% of the profits 135-100=35x.20= 7M. You are just using the set hurdle rate to test if they get carried interest or not, if they do, they get their %, if not, they get nothing…it all goes to the LP investors. Be careful that if the GP also contributed money, they get 80% of the profits as part LP plus 20% carried interest as GP. -Interpretation compliments of CAIA Program.

#4

Thanks!