How to Answer “How do you calculate IRR and MOIC, and when can they disagree?” in Private Equity Interviews
In private equity interview prep, one of the most common return-metrics prompts is: “How do you calculate IRR and MOIC, and when can they disagree?” A strong answer is part mechanics (cash flow set-up), part interpretation (what each metric is actually rewarding).
To do well, you should be able to calculate IRR and MOIC off the sponsor’s equity cash flows, explain the intuition (speed vs magnitude), and give a few tight scenarios where the metrics diverge because of timing and interim distributions.
What Interviewers Look For in an IRR Calculation Interview
In an IRR calculation interview, interviewers are checking whether you understand IRR as the discount rate that zeroes NPV for a dated equity cash flow schedule—not as an Excel button. At associate level, they’ll expect you to state the sign convention, identify which cash flows belong in equity IRR, and call out why IRR can behave strangely with irregular cash flows.
With MOIC explanation, they’re testing whether you can cleanly separate “how many times our money” from “how quickly we got it back.” They also want to see if you include real-world items like transaction fees funded by equity and recapitalisation distributions.
More broadly, this is a staple of private equity technical questions and any investment metrics interview: can you interpret trade-offs and communicate them crisply? The best answers connect each metric to the deal timeline (holding period, interim cash returns, exit proceeds) and explain when one metric can look “better” without the underlying deal necessarily being better.
Step-by-Step: Calculate IRR and MOIC for PE Deal Returns
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Step 1: Define IRR vs MOIC and set the equity cash flow perspective
Start with two definitions and one intuition line.
- MOIC (Multiple on Invested Capital) measures total value returned relative to total equity invested: MOIC = (Distributions + Residual Value) / Paid-in Equity. It ignores time.
- IRR (Internal Rate of Return) is the annualised rate r that sets the NPV of all equity cash flows to zero: (\sum_t \frac{CF_t}{(1+r)^t}=0). It depends heavily on timing.
Then anchor the modelling perspective: you’re calculating returns to the sponsor’s equity. Equity contributions (purchase equity, fees funded with equity, add-on equity) are negative; distributions (dividends, recap proceeds, sale proceeds net of debt and costs) are positive. Stating this up front prevents the most common interview confusion: mixing enterprise cash flows with equity cash flows.
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Step 2: Walk through MOIC calculation in a deal model (money in vs money out)
Explain MOIC like you’re describing the equity bridge in an LBO model.
- Total equity invested (denominator): start with the equity cheque at close and include any follow-on equity contributions. If you’re being precise, include transaction fees funded by equity and any equity-funded working capital needs.
- Total value received (numerator): sum all cash distributions over the hold (dividends, management fee rebates if applicable, and especially debt recap distributions) plus the final exit equity proceeds.
- Exit equity proceeds: typically exit enterprise value – net debt – transaction costs (and any other adjustments required by the case).
Compute MOIC = (sum of all positive equity cash flows) / (absolute value of sum of all negative equity cash flows). Emphasise the key property: MOIC is stable and easy to interpret even with irregular timing because it’s purely cumulative dollars in versus dollars out.
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Step 3: Walk through IRR calculation (what data you need + how you solve it)
Keep the IRR mechanics date- and cash-flow-driven.
- Build a schedule of dated equity cash flows: initial close (big negative), any interim equity contributions (add-ons, rescue equity), interim distributions (dividend/recap), and the final distribution at exit.
- Solve for the discount rate that makes NPV zero. In Excel, that’s IRR if periods are evenly spaced, or XIRR if you’re using actual dates.
Add two quick checks that show modelling maturity:
- If there’s only one outflow and one inflow, IRR should roughly align with MOIC^(1/years) − 1.
- If you add an early distribution (e.g., recap) without changing total value, IRR should increase because cash comes back sooner.
This frames IRR as “time-weighted cash flow performance,” not a spreadsheet trick.
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Step 4: Explain when IRR and MOIC disagree (tight buckets + the why)
Give 3–4 categories that cover most interview cases and explicitly state the driver.
- Holding period differences: The same MOIC can imply very different IRRs (2.0x in 3 years vs 2.0x in 7 years) because IRR annualises.
- Interim distributions (dividends / debt recaps): Returning capital early typically raises IRR even if MOIC is unchanged; IRR rewards earlier cash back.
- Back-ended outcomes: A deal can have a strong MOIC but a mediocre IRR if value is realised late (long hold, no interim cash flows).
- Non-normal cash flows: If cash flows change sign more than once (partial sale then reinvestment, follow-on equity after distributions), IRR can be unintuitive or even have multiple mathematical solutions; MOIC remains interpretable as a cumulative multiple.
Close the interpretation: in private equity underwriting you usually look at both—MOIC for “value created,” IRR for “capital efficiency and timing.”
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Step 5: Add a mini example and a decision lens for interviews
Finish with a short example you can say out loud and a practical takeaway.
Example (timing effect): invest 100 and receive 200 at exit.
- MOIC = 2.0x regardless of timing.
- If the exit is in 3 years, IRR is meaningfully higher than if the exit is in 6 years (same multiple, slower money).
Example (early distribution): invest 100; receive 30 in year 2 via recap; receive 170 at exit in year 5.
- MOIC still 2.0x, but IRR rises versus receiving the full 200 only at year 5.
Decision lens: when asked when do IRR and MOIC disagree in interviews, I explicitly cite (i) holding period, (ii) interim distributions, and (iii) irregular cash flows, then I sanity-check directionally before discussing exact numbers.
Model Answer for Investment Metrics Interview (IRR vs MOIC)
MOIC tells you how many times you made your money; IRR tells you how quickly you made it. To calculate both, I start from the sponsor’s equity cash flows: equity contributions are negative, and distributions—dividends/recaps and final exit proceeds net of debt and costs—are positive.
For MOIC, I take total value received divided by total equity invested: MOIC = (cumulative distributions + residual equity value at exit) / paid-in equity. In a model, that’s essentially the sum of all positive equity cash flows over the absolute sum of the negative equity cash flows.
For IRR, I set up the dated equity cash flows—initial close, any follow-on equity, interim distributions, and the final exit distribution—and solve for the discount rate that sets NPV to zero. Practically I’d use IRR for equal periods or XIRR when using actual dates.
They can disagree because MOIC ignores timing while IRR is very sensitive to it. The same 2.0x outcome has a much higher IRR over three years than over seven years. They also diverge when there are early distributions like a dividend recap: MOIC may be similar, but IRR increases because capital is returned sooner. Finally, with irregular or non-normal cash flows—such as partial exits followed by reinvestment—IRR can behave oddly or even be ambiguous, while MOIC remains a clean “dollars in versus dollars out” measure.
- Open with the intuition (magnitude vs speed), then move to equity cash flow mechanics.
- Explicitly state sign convention and that you’re using sponsor equity cash flows.
- Name interim distributions/recaps as the most common real-world reason for divergence.
- Mention IRR vs XIRR as a dates issue; avoid over-focusing on Excel syntax.
- Give one clear disagreement example (timing or recap) rather than many half-examples.
Common Pitfalls in MOIC Explanation and Return Metrics
- Calculating returns on the wrong cash flows (using enterprise cash flows instead of sponsor **equity** contributions and distributions).
- Forgetting timing entirely: stating MOIC correctly but not explaining why IRR changes with holding period.
- Leaving out interim distributions (dividends/recaps), then giving the wrong direction for how IRR moves.
- Ignoring fees/transaction costs funded by equity, which can distort both MOIC and IRR versus what the model implies.
- Over-claiming IRR is always “better”; strong answers explain when IRR can be misleading with non-normal cash flows.
- Using IRR mechanically without a sanity check (e.g., whether the implied annualisation is plausible given MOIC and duration).
Follow-Ups in Private Equity Technical Questions on Returns
How do you approximate IRR quickly from MOIC and holding period?
If it’s one outflow and one inflow, use IRR ≈ MOIC^(1/years) − 1 and then adjust your intuition for interim distributions.
Which is more important for comparing two deals: IRR or MOIC?
I use both: MOIC anchors total value creation, while IRR helps compare opportunities with different durations and cash-return timing.
How does a dividend recap typically affect IRR and MOIC?
It usually increases IRR because cash comes back earlier; MOIC may be unchanged if total value returned is similar, though risk can rise due to higher leverage.
Can IRR be problematic mathematically?
Yes—if cash flows change sign multiple times, IRR can be unintuitive or have multiple solutions; MOIC stays interpretable as total in vs out.
What cash flows belong in a private equity equity IRR?
All sponsor equity contributions and distributions: close, follow-ons, interim dividends/recaps, and net exit proceeds after debt repayment and transaction costs.
Financial Modeling Interview Practice: Build Speed and Accuracy
- Practise a 60–90 second “step-by-step guide to IRR and MOIC calculations” aloud: definitions → equity cash flow set-up → when they disagree.
- Memorise one reusable numeric example (2.0x in 3 vs 6 years, or a recap) and use it to explain directionality under pressure.
- Drill common pitfalls in IRR and MOIC calculations for interviews: sign convention, missing fees, missing interim distributions, and mismatching dates.
- Do a timed mock on AceTheRound where the interviewer changes the timeline (earlier exit, partial sale, recap) and you explain how IRR and MOIC move without re-building the model.
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