If a $100 PIK note is called at year 5 and you originally paid $100, what is the approximate IRR?

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Multiple Choice

If a $100 PIK note is called at year 5 and you originally paid $100, what is the approximate IRR?

Explanation:
PIK notes accumulate interest by adding the interest to the principal, not paying it in cash. If you invest 100 today and the PIK rate is r each year, after 5 years you owe 100*(1+r)^5. When the note is called at year 5, you receive that amount. The IRR is the annual rate that turns your initial 100 into that final payout over five years, so IRR = (Final/100)^(1/5) − 1. Since Final/100 = (1+r)^5, IRR = r. Thus, if the PIK rate is 10%, the IRR is about 10%.

PIK notes accumulate interest by adding the interest to the principal, not paying it in cash. If you invest 100 today and the PIK rate is r each year, after 5 years you owe 100*(1+r)^5. When the note is called at year 5, you receive that amount. The IRR is the annual rate that turns your initial 100 into that final payout over five years, so IRR = (Final/100)^(1/5) − 1. Since Final/100 = (1+r)^5, IRR = r.

Thus, if the PIK rate is 10%, the IRR is about 10%.

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