Question

Suppose a private equity fund has $100 million in committed capital and its base rate for management fees is 2%. The fund invested in 10 companies during the first 5 years and begins to exit its investments in year 6 at the rate of two exits per year until the end of year 10, when all investments have been exited. Assume the original cost basis for each investment is $10 million. Also assume that fees calculated on net invested capital are based on year-end balances. How much in lifetime management fees does the firm earn, based on each of the following two methods?

Answer 1

The private equity fund would earn a lifetime management fees of $8 million based on the given scenario.

Step-by-step explanation:

To calculate the lifetime management fees, we need to calculate the net invested capital at the end of each year and apply the management fee percentage of 2%.

In the first 5 years, the fund invests in 10 companies with an original cost basis of $10 million each, resulting in a total net invested capital of $100 million. The management fee for year 5 would be 2% multiplied by $100 million, which is $2 million.

In year 6, the fund starts exiting its investments at a rate of two exits per year. Assuming each exit is at the original cost basis of $10 million, the net invested capital decreases by $20 million each year. The management fee for year 6 would be 2% multiplied by $80 million (net invested capital at the end of year 5), which is $1.6 million. Following this pattern, the management fees for year 7, 8, 9, and 10 would be $1.4 million, $1.2 million, $1 million, and $0.8 million respectively.

Summing up all the management fees, the lifetime management fees earned by the firm would be $2 million (from year 5) + $1.6 million + $1.4 million + $1.2 million + $1 million + $0.8 million = $8 million.