CFA Institute CFA-Level-II Exam - Topic 3 Question 86 Discussion

The New York-based Irwin Goldreich Schmidt (IGS) is a mid-sized private equity firm with $300 million capital raised from its investors. Amid a turbulent year, the firm has recently dropped its unsuccessful $100 million bid for a Norwegian media company and is now aggressively searching for new venture or buyout investments in the Eurozone. After several months of intense search IGS believes it identified two potential investments:

1. Sverig, a rapidly expanding Swedish start-up construction company.

2. L'Offre, a struggling French department store in existence since the late 19th Century.

Following several rounds of successful negotiations, IGS makes a $20 million investment in Sverig and a $100 million leveraged buyout investment in L'Offre, committing to an additional $100 million for possible future capital drawdowns. It retains all of Sverig's managers but replaces L'Offre's management team with experienced IGS managers, many of whom are former company senior executives.

IGS also sets up Sverig-L'Offre Private Equity Fund (SLPEF), a fund to manage both firms. The fund manager's compensation is set at 20% of profits net of fees. IGS also specifies that the manager's profits are calculated on the entire portfolio when portfolio value exceeds invested capital by 30%.

Despite the market's recent turbulence, Sverig's original founders are extremely optimistic and believe the firm could be sold for $400 million in six years. To achieve this, they speculate the firm needs another capital infusion of $40 million in four years in addition to the $20 million capital investment today. Given the high risk of the firm, SLPEFs private equity investors decide that a discount rate of 40% for the first four years and 30% for the last two years is appropriate. The founders of Sverig want to hold 5 million shares.

An appropriate equity valuation technique for Sveng and L'Offre, respectively, would be the:

Sverig L'Offre