Suppose you buy a company which has $20 million of EBITDA for 5x EBITDA. You fin

Question

Suppose you buy a company which has $20 million of EBITDA for 5x EBITDA. You finance it with $30 million of equity and $70 million of debt. Five years later the company has $30 million of EBITDA and you sell it for the same EBITDA multiple you paid, 5x.

1. What is the IRR for your equity, assuming the interim cash flows all went to pay taxes, capex, etc. and not to pay down debt prior to the sale of the company.

2. What is the IRR for your equity, assuming the interim FCF was used to pay the debt down to zero?

Explanation / Answer

1) Value of firm in 5 years = EBITDA x Multiple = 30 x 5 = 150 million

If debt remains at 70 million, then equity = 150 - 70 = $80 million

IRR can be calculated using I/Y function on a calculator

N = 5, PV = -30, FV = 80, PMT = 0 => Compute IRR = 21.67%

2) If debt is zero at the end of five years, then equity = $150 million

N = 5, PV = -30, FV = 150, PMT = 0 => Compute IRR = 37.97%

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