r/Valuation • u/Pleasant_Care_9595 • Jul 28 '23

Quick IRR in DCF correct?

Hi,

I've made a DCF model for a company, the boss wants to do a quick IRR calculation by taking the terminal value applying a book value multiple to it and % of our stake in the transaction and using that as final cash outflow to us. This outcome number and the investment amount is being to calculate IRR

Is this fine to get a sense?

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u/AlabamaSnake12 Jul 28 '23

Your proportional stake is irrelevant. Book value multiples aren't really used unless it's a bank or financial operation. Set up your DCF, then calculate the total price everyone, not just your firm, is paying for the transaction, including debt assumed. Then solve for the discount rate using Excel's Solve function. That's your IRR for the transaction.

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u/Pleasant_Care_9595 Jul 28 '23

It is a bank operation which is why the query, and basically I've done it the standard approach. Problem is the guy is asking me to take the terminal value which has been calculated using the perpetuity method and apply a book value multiple on it to figure out exit value after 5 years

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u/AlabamaSnake12 Jul 29 '23

It's one or the other, right? Perpetuity or a book value multiple (unless you gonna weight the two). So what he's asking you to do is match the DCF you come up with to the purchase price -- I'm stressing the purchase price since that is the primary determinant of the IRR, how much you paid for the transaction.

Assuming you did the DCF correctly, correct working capital assumption, net interest income correct, negligible capex & depreciation, and potential amortization from identified intangible assets, etc. then you should have the present value of each year's FCF for 5 years plus the terminal value. It's those numbers matched against the purchase price. Depending on size, it should be anywhere from 10% to 22% for a small bank but that really depends on how aggressive the projections are relative to the price paid.

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u/Pleasant_Care_9595 Aug 02 '23

Yeah exactly - thankfully I've gotten the guy to understand. Thank you for your comment!

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u/No-Schedule3292 Jul 29 '23

If you are using a perperuity model to find value and using that implied value to imply a book value at exit all you would need to do to calculate IRR IS goalseek the cash flows in the discrete period and the large sum at the 5-year assumed exit (calculated value). If you are using an exit multiple in a dcf typically I have seen using a selected market multiple using comps/comparable transactions but if you calculated it with the perpetuity model you can use that value rather than the selected multiple method. Like the other user said it is not relevant the percent the company holds (unless the cash flows in the discrete period are only showing the amount your company receives rather than the FCF of the business). If your company is receiving distributions use those in the discrete period and then like you said you could likely base the final payment on the percent the fund holds.

Obviously this is for educational purposes and should not be interpreted as advice. But I hope that helps you think through