PT.2 FIN 655 [5] Private equity funds typically have a lifetime of 10 years, in which the first 5 years are the investme

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PT.2 FIN 655
[5] Private equity funds typically have a
lifetime of 10 years, in which the first 5 years are the investment
period (only in new investments) and the last 5 for follow-on
investments and in exiting portfolio companies. The management fees
to be paid to the General Partners are typically assessed using 1
of the following 4 methods:
(i) a
constant percentage of committed capital;
(ii) a
decreasing fee schedule with the percentage falling by 0.25% per
year after the
investment period (after year 5);
(iii) a
constant rate for the first 5 years with committed capital basis
and the same
percentage with invested capital basis
in the last 5 years;
(iv) a
combination of methods (ii) and (iii).
Suppose a PE fund has $100 million in committed capital and its
base rate for management fees is 2%. It has invested in 10
companies during the first 5 years and begins to exit the
investments in year 6 at a pace of 2 exits per year until the end
of year 10, when all investments have been exited. Assume the
original cost of basis for investment is $10 million each and the
fees are calculated on the net invested capital based on year-end
balances (that is after the payment of management fees). How much
in lifetime management fees does the PE firm earn, based on EACH of
the 4 methods described above?
[6] If your PE fund has acquired a company
that has had an average EBITDA of $30 million in each of the past
several years, and your fund having a leverage multiple of 5x paid
8x EBITDA for it. After the acquisition, with the help of the
senior management of the company, you were able to introduce
measures that were able to improve the profit margin, barring
unexpected situations. You are now about halfway of your plan to
exit at the end of 5 years, at which time you expect the company
will have the following financial data:
Low-end Projection
High-end Projection
5 years’ cumulative excess cash to pay down debt
$47.5 million
$50 million
Project EBITDA at end of year 5
$32 million
$35 million
Exit multiple
8x
9x
What would be the different IRRs at the 5-year exit, by using
the following assumptions:
[7] A PE fund is investing $120M in a
target that expects to require no further capital injection
throughout the investment horizon of 5 years. In year 5, the
acquired company is expected to have net earnings (EBITDA) of $58M
and the PERS at the time will remain at 7. If the PE fund requires
a risk-adjusted 25% projected IRR for this investment, what
percentage of the company the fund has to own at the time of the
acquisition? If at the time of the acquisition, the fund had a
leverage multiple of 3x. How much of the acquisition price was
raised from debts? (Please ignore the effects of fees, interests
and other payments in the calculation.)
[8] Private equity funds, hedge funds and
mutual funds are all private pools of investment capital. Please
compare them in the following aspects:
(i) Participating
investors
(ii) Typical
capital structure
(iii) Fees
charged by management
(iv) Regulatory
environment
(v) Target
assets
(vi) Trading
strategies.
Please also explain the concepts of “absolute returns” and
“high-water marks” in hedge funds.
[9] Assuming you are a well-known hedge
fund manager invited to a technology conference, in which you
separately met with the senior management of 2 established
companies, ISI Corporation and AMA Inc. You were given details of
the new products that had just been announced by them and were
about to be introduced to the market. After subsequent study and
research, you believe that the product offering of AMA would likely
be a winner in the market and the effects will become clear within
a year. Assuming the stocks of both AMA and ISI are traded at $50 a
share and the business journal at the time shows the following
1-year option prices:
$50 Call Option
$50 Put Option
AMA Inc.
$3.50
$4
ISI Corporation
$4.50
$4
If the going interest rates at the time is 5%, and neither AMA
nor ISI pays dividends this year and in the coming years (typical
of technology companies, due to the need to heavy R&D), as a
long/short hedge fund manager, what options trade should you
execute in this scenario?
(Note: a call option is the right to buy the underlying stock at
the specified price, and a put option to sell.)
[10] There are 2 types of investment
bankers. One type specializes in “products” or “functions” for
their clients. Within this “products” type, an important functional
group, which usually generates substantial revenues for the
investment bank or investment banking division, is
mergers-and-acquisitions (M&A). (a) Please name the 6
functional work assignments for M&A investment bankers; (b)
Between a sell-side transaction and a buy-side transaction, which
one would you think have higher probability of completion and
explain; and (c) Before the official announcement of the M&A to
the public, do you think the investment banker should disclose the
ongoing negotiation to anyone who is not a party in the
negotiation?