Talk:Enterprise value

Can anyone please explain, why the company value changes, when a company buys assets?? — Preceding unsigned comment added by 92.74.154.167 (talk) 14:15, 18 March 2020 (UTC)

Rewrite
The edition I overwrote included a lot about how EV is 'correct' or 'better'. It isn't. It measures a different thing. There was also stuff about how it measures a take over value. This is very wrong. While it might be used by someone buying just the assets (who would then apply their own cost of capital and taxes onto it), it will never be a takeover value because it ADDS the debt value. You never pay MORE for privilege of assuming debt. Retail Investor 18:57, 25 November 2006 (UTC)


 * Enterprise value is very relevant to takeover discussions. It represents all the financial stakeholders--if you ignore the value of a firm's debt you could be ignoring a very significant portion of its capitalization.   It doesn't imply that you "pay more for the privilege of assuming debt." For example, if a company had a equity value of $10 and debt of $10, its EV is $20.  If you took over the company by buying all of the equity, you will assume all the debt and thus part of the consideration paid is the $10 in debt assumed.   In some cases, a buyer will want to recapitalize the company.  If you wanted the new capital structure to be debt-free, you'd have to buy out all the debtholders, and again using the above example the total value would be the $10 in equity and $10 in debt.


 * You misunderstand my comment because you did not review what I had deleted. It used to say EV was the "theoretical takeover price".  To use your example, it said the common equity was worth $10+$10=$20.  And if the debt was $30, then the common equity stake would be worth $40.  That was obviously wrong.  I don't disagree the metric is 'relevant'.

Subtracting cash in EV calculation makes all the sense. The company's cash flows, post WC and and Capex, have to be divided between the funding entities of the company, equity and debt holders. If you have 100USD in cash, you can repay debt holders and leave more of the future cash available for equity holders. Net debt therefore makes sense. A doubts arises when we do not consider receivables as cash. Eventually they will materialize into cash. Imagine a company decides to sell (securitize) all of its receivables to athird party in exchange for cash (assume no bad receivables). This would influence the net debt value, therefore equity value even when the fundamental value of the company has not changed. Any suggestions? unsigned comment added by 193.238.54.20 (talk) 10:06, 18 April 2011 (UTC)

I disagree with cash in equation
I deleted the reference to cash in the equation, because the value of cash is already included in the market value of the common equity.Retail Investor 18:57, 25 November 2006 (UTC)


 * Right, which is why excess cash is subtracted from the value.  This is a necessary step when coming up with a capital structure-neutral measure of valuation.  mullacc 00:41, 30 November 2006 (UTC)

I don't agree. Cash is an asset like any other. EV measures the market value of the assets. Those assets are owned (and valued) by the long-term debt and equity owners. EV measures the total.

In reality EV measures the market value of owning all non-cash assets of a company, including intangibles and brand, and being obligated by all liabilities that have no expectation of a return (like payables, etc.). Because EV is used in models containing some profit/cash flow, it is used in metrics of return. Free cash can't be expected to create a return from this perspective, and the owner will have no obligation to create return for the remaining liabilities.

Some EV definitions exclude cash; others do not. Those that do clearly do not agree that "cash is an asset like any other." It is the only asset being purchased that can immediately be used to help with the purchase price. For example. You sell me a car for $10,000 and we both acknowledge that the stereo, tires, etc. plus a $1,000 bag of cash in the trunk all come with the car for the agreed price. Once you give me the car, I will give you the cash. I only need to show up to the transaction with $9,000. —Preceding unsigned comment added by 75.53.43.103 (talk) 03:47, 13 June 2009 (UTC)


 * I've never thought of it as a "market value of the assets", but rather the market value of the on-going enterprise. Unlike other assets, cash (beyond a small amount needed for operations) is not essential to operations.

If EV doesn't value the total of assets. And it doesn't measure the market value of all owners, what DOES it measure? Why would one define 'on-going' as everything but cash?


 * And when doing an "apples-to-apples" comparison to similar companies with different capital structures/cash balances, it is essential to take cash out of the picture.

Why? You normalize for the capital structure, not the assets.

Consider two companies with exactly the same balance sheet except the second has excess cash of $10,000. The market value of their debt will be exactly the same. The market value of the common equity will be $10,000 higher for the second company. Your equation says that the EV of both is the same. Why on earth? The second has $10,000 more assets. Why is it not worth $10,000 more?

It is worth $10,000 more, and that will be reflected in the market value of the equity (if the market is efficient). But that $10,000 need not be possessed to buy the company. It could be borrowed for a day.


 * Because cash is just a component of the company's capitalization.  If the company took that extra $10,000 in cash and paid down debt or paid a dividend to shareholders, its EV would not change but its equity value would.   Since EV is a capital structure neutral methodology, the company with the excess cash should have the same EV and EV/EBITDA multiple as the other company.  In this sense, excess cash is simply an opportunity to pay down debt, pay a dividend or buy back equity--all capital structure considerations.

Theoretically, this is wrong. A dividend paid to investors in theory reduces the share price by the amount of the dividend on the ex-dividend date. Thus, the cash decreases while the market cap also decreases by an identical amount. Thus the EV stays the same. Likewise, paying down debt reduces both cash and debt simultaneously, keeping EV the same. That's how it is capital structure neutral. Otherwise, a company could reduce its EV by paying dividends / debt.

And that dividend makes the second company worth more before the payment than after it has been paid out. Cash is an asset, not 'a component of capitalization'. Capitalization is about who OWNS the assets. It has nothing to do with the assets themselves.


 * Here is a practical example: a public company is being taken private by a private equity firm who will be using a significant amount of debt to purchase the company.  Let's say a company has $10 in equity value, $10 in debt, $5 in cash and $3 in LTM EBITDA.   Let's assume the purchase price is equal to market value and the PE firm will take out the existing debt.   The total enterprise value will only be $15 because the $5 in cash will be used to paydown the debt ($10 of equity + $10 of debt - $5 of cash).

This example doesn't prove anything. There is only one company. The point of EV is to normalize between two different companies. My example above proves the second company is more valuable, because the new owners of it could take a $10,000 dividend. AND they would still have the company


 * I think the logic of the equation can stand on its own, but it also happens to be common practice in professional usage.  Corporate finances texts subtract cash and private equity, equity research and M&A folks also use the same methodology.  If necessary, I can point you to SEC S-4 filings where investment banks calculated EV as part of their fairness opinion.   A look at some equity research reports should also show the same result.

Quoting someone else is no argument. If you are an investor, you know that "fainess opinions" are anything but fair.

The Enterprise Value is NOT what one theoretically pays to the current owners (equity) to purchase the company. That value is essentially the Market Cap. It's the amount of money one must produce to buy out a business free and clear (while pocketing no cash). You state no one would pay $10 more for the right to assume $10 debt. That's correct. The $10 is NOT in the theoretical buyout paid to the equity to assume the debt. Subsequently to buying out the equity the $10 is paid to the debtholders to eliminate the debt. Likewise, a company with $10,000 more in cash would have a lower EV, since that cash is used either in the purchase or debt payoff and thus doesn't need to be possessed by the potential buyer.

The EV/EBITDA multiple
The phrase "EV/EBITDA measures the payback period of the whole capital structure" is incorrect, or at least unclear. It cannot represent any sort of "payback" because EBITDA leaves out, among other things, significant cash flow items such as capital expenditures and changes in working capital. I'm going to revert back to my language on EV/EBITDA because I think it points out the more relevant information and I think the comparison to P/E multiples is helpful. The language could use be more concise though, so I'm open to those type of edits. I also made some formatting changes to the formula. mullacc 00:41, 30 November 2006 (UTC)


 * I don't agree with any of that either. Retail Investor 22:39, 1 December 2006 (UTC)

Well, it'd be helpful if you explained what you meant by a payback period.


 * Why did you decide it was wrong if you didn't know what it is? When a value is devided by a measure 'per year', the result is pure math - a number of years. The other stuff you talk about is really about "free cash flow" that is a measure pertainent to common share holders only - not debtholders.  You are way off topic.


 * I decided it was wrong because it is nonsensical. When people use EV/EBITDA, it is almost always for purposes of valuing the equity.  Debtholders are more likely to worry about Debt/EBITDA and Debt/Equity ratios.   You said "EV/EBITDA measures the payback period of the whole capital structure"--I understand what you're trying to get at, but this notion of payback periods is more relevant to P/E ratios where all of earnings are in some way claimed by equity holders.  But you cannot make this same statement with EBITDA because a company    will be spending cash on a handful of others things (capex, taxes, interest, changes in working capital, etc) before debt principal can theoretically be paid or before equity-holders can lay claim to anything.   There is certainly a place for proper discussion of payback periods, but it is probably under value investing for the equity side and credit analysis for the debt side--to put it here just confuses the nature of EV and EV/EBITDA.mullacc 05:45, 2 December 2006 (UTC)