div recaps and irr

I have looked through old threads but not really satisfied with explanations

The BIWS guide states that div recaps should boost returns because of more debt, but this answer does not seem to be true.

How do you know generally whether or not the div recap will boost returns? Because you also have the effect that cash flows come in earlier which should boost IRR

Steeeeeeeeve

There is less equity in the company because the investor already realized a return from recapping some of the equity - i.e the cash in hand from the recap will be added to the equity from the exit sale and that'll make up the cumulative IRR

LBO Modeling Course

but how does a div recap affect IRR and MoIC?

Steeeeeeeeve

The more equity you pull out aka the more leverage you use and can sustain, the higher your MOIC and IRR. IRR is a present value metric while MOIC is just a cash on cash return

But how come many say that MoIC tends to decrease with a div recap and IRR can decrease?

Look at multipleexpansions div recap example. in that model, MoIC decreases as does IRR..

1 reply

pe mvp

Unless the cost of debt exceeds the unlevered return (from growth + fcf yield), it should be IRR accretive and MoIC netural or slightly negative due to higher overall interest expense over the holding period. You're just pulling money out earlier.

Authored by: Certified Private Equity Professional - DirectorCertified Private Equity Pro

Hi,

Why unlevered return and not levered return as levered cash flows? What do you mean by unlevered return here (why growth and fcf yield specifically)?

ebit_dab

Authored by: Certified Private Equity Professional - 3rd+ Year AssociateCertified Private Equity Pro

leftlead

Most Helpful

Assuming no refinancing/txn costs, a dividend recap will boost IRR provided that the post-tax cost of debt is below the pre-recap IRR (cost of equity).

This is assuming that the additional debt from the recapitalisation is not paid down. If it was, then you may be able to achieve an IRR boost even if the post-tax Kd is higher than pre-recap IRR.

The easiest way to think about is as follows: the recap debt financing injected is 1-for-1 with the equity financing removed (assuming no costs), therefore if your Kd post-tax is higher than your pre-recap Ke, you're effectively replacing equity financing which has a lower cost (IRR pre-recap) than the cost of the debt financing being injected. As such, levered returns (represented by the equity IRR) will fall.

The MOIC is independent of time - there is no scenario in which it improves as a result of a recapitalisation ceteris paribus. It will decline if there is an interest cost on the additional debt injected into the business (100% of the time in an efficient market).

Authored by: Certified Investment Banking Professional - 2nd Year AssociateCertified Investment Banking Pro

Thanks. your answer seems to differ quite a bit to the answer above. do you have a source?

Associate 2 in AM - Other

Not that poster, but I had this question in an interview once and this answer is basically exactly what they were looking for, i.e. if equity return is higher than the cost of debt it’ll boost IRR and if not it’ll decrease IRR. Assuming a constant exit price, MOIC decreases given the increased interest paid over the deal’s life.

Authored by: Certified Hedge Fund Professional - Vice PresidentCertified Hedge Fund Pro

finthusiast1313

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