To calculate the returns from an investment you need a series of information about the investment. And you can see here in the table, we've got a number of different columns. The first column is a set of labels and then we've got two columns, first called entry and then the second called exit. And this means that the information in the entry column is for when the company was purchased or when we made the investment. And the information in the exit column is when we sold the investment. Now in this case, we're assuming that we buy the business, which is effectively year zero and then we sell the business in year four. So there's four years difference between the entry column and the exit column. The first piece of information that we've got is our EBITDA, which is a key earnings metric here and at entry it was 36.3 million. We are estimating that when we sell the business it will be 45 million and that's based on our forecast or the management's forecast that of course we'll have to be fairly comfortable with. The next item is the EBITDA multiple. This is the multiple of EBITDA that we expect to be able to, in the case of the exit, sell the business and in the case of the entry, the price we paid for the business. So in this case, we paid eight times EBITDA at entry and then sold the business four years later for nine times EBITDA. If we multiply through, take the EBITDA month number multiplied by the multiple, we'll get the enterprise value, the value of the whole firm and this is the value of the firm available to both debt lenders and equity investors. Now, the next piece that we've got here are some assumptions for the debt investment and the equity investment. Now, the debt is going to be based on the debt capacity of the business. In other words, how much the lenders will lend us to help buy the business. And in this case, we're assuming that they'll lend the majority of the investment which is 217.8 million. This means that we've got to put the remaining piece in as an equity investment. So we calculate the equity investment by taking the enterprise value minus the debt to give us how much equity we need to invest and we are, as a result, expecting to invest 72.6 million. Now of course, as you can see the EBITDA has increased and we expect to sell the business for a higher EBITDA multiple, there's going to be a fairly dramatic increase in the enterprise value. And the enterprise value has gone from 290.4 million when we bought the business to an estimated 405 million when we sell the business. Not only that, we're also forecasting that the business will help repay some of that debt and we expect the debt to fall from the 217.8 million down to 152.5 million.

And just as you repay a mortgage on the house the value of your equity in the house will increase. So as a consequence of this, if we take the 45 million multiplied by nine to get our enterprise value of 405 million at exit, we take that, we subtract the debt we expect to have at exit of 152.5 million. We get our estimated equity value of 252.5 million. A substantial increase on the investment that we made of 72.6 million. Now, that's an absolute dollar figure. What it's useful to do, is express that as an internal rate of return. Now, in this case, because we only have two cash flows, the initial investment of 72.6 million and the exit value of 252.5 million, we can use a simple compound annual growth rate formula to calculate the average yearly return we will get from investing that 72.6 million in the equity of this transaction. So we can take, as you can see on the right here, the equity value on exit, which is the 252.5 million and then divide that by the original investment of 72.6 million. Put that in parentheses and then take it to the power of one quarter. And it's one quarter because in this case we're assuming that there are four years between when we made the investment and when we sold the investment. Finally, we just need to subtract one and that will give us the average yearly growth rate in our equity, which is 36.6%.

And that means we can then start comparing that return to our other investment opportunities of a similar timeframe. So this means in total, if I took the difference between the 72.6 and the 252.5, we will have created value of 179.9 million. But actually we will generally want to break that down and understand where that value creation came from. And there are a number of different things that have helped to create value in this transaction. The first is that we repaid some of the debt. The debt went from 217.8 million down to 152.5 million.

The debt fell by 65.3 million. If the debt falls and the enterprise value stays constant, all that value will go to the equity holders. So of the 170.9, 65.3 million of it came from the debt repayment. The other item here is the increase in EBITDA. And in this case, we sold the business when it had an EBITDA of 45 million. If we subtract from that the original EBITDA number of 36.3 million, that will give us the increase in the EBITDA. And if we multiply that by the original multiple of eight times, this will give us the value that's being created simply because the earnings increased in the business. And that in this case is 69.6 million. So we've got two elements of our value creation, the fact that debt was repaid, number one and secondly, the EBITDA increasing, which will flow again to equity holders because debt holders just have a fixed claim against the business. Now lastly, the third element of value creation is the fact that we bought the business on eight times EBITDA and then we sold it on nine times EBITDA. And this could be because we were just lucky and it was a hot market at the end, or it could be that we bought well, we identified an asset that we thought was undervalued and bought it at a low multiple. We can calculate how much value was created from this by taking the exit multiple, which in this case is nine times, subtracting the entry multiple of eight times and then multiplying that by the EBITDA. Now, in this case, we've only got one turn because nine minus eight is one, multiplied by our exit EBITDA of 45 million, which obviously gives us 45 million in value creation. So these three items together added up will equal the total value created and that total value created of 179.9 million is equal to the increase in the value of the equity.

So we've broken down not just the returns from making an investment to equity holders, but where those returns have come from.