medium · Private Equity paper-lbo
A sponsor invests $175.0 million in Year 0. In Year 3, the sponsor executes a dividend recapitalization, returning $125.0 million. In Year 5, the company is sold, and the sponsor receives $535.0 million.
How does the Year 3 dividend recap affect the Internal Rate of Return (IRR) compared to a 'no-recap' scenario that yields the same total cash of $660.0 million at Year 5?
- The IRR increases because cash flows are pulled forward in time.
- The IRR decreases because the company carries more debt, which is a risk factor in the formula.
- The IRR decreases because the sponsor's basis in the company has not been reduced.
- The IRR stays the same because the Total Multiple on Invested Capital (MoIC) is identical.
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