I was puzzled for a few second but then reverted back to accounting: increased the cash balance like that will simultaneously increase equity. Then, going back to the EV formula, the increased equity will be balanced out by the subtraction of cash. I saw it later in the video.
Александр Вальцев Yes, that is exactly correct. Increasing the cash balance should, in theory, also increase the company's Equity Value since Equity Value reflects the value of everything the company has. And then the increased Equity is balanced by the subtraction of cash in the Enterprise Value formula.
@@financialmodeling Why should we deduct non-operating assets? Let's say we have an operating asset on balance sheet, the value of which is estimated by the DCF model and also we have on the balance sheet is not an operating asset (for example, real estate). So if EV is the value of a company's core business, why should we deduct the value of non-operating asset? There is no sense. Non-operating assets have no relation with core business. We have to add them up to get the value of the whole company.
@@Dmitry-dy9yi Um, you do add non-core or non-operating assets to get the value of the entire company. That's what happens at the end of a DCF when you move from Implied Enterprise Value to Implied Equity Value. But the point is that you can only *pair* All Assets with Equity Value, and you can only *pair* Core Operating Assets with Enterprise Value. No one is arguing that non-operating assets are worthless; it's just an issue of which set of Assets you pair with which metric.
What would happen to the EV if the company takes on debt $2m and invest that cash in a project with a NPV of $3m? Thanks for your sharing, your points are well thought!
Depends on how the project is recorded on the Assets side. If it's recorded at its Book Value of $2 million, Enterprise Value increases by $2 million because Net Operating Assets go up by $2 million. If it's later revised up to $3 million, Enterprise Value increases by $3 million instead.
Sir, i have a little doubt, let's say I am gonna purchase a company having ,equity of 2000$, debt of 1000$, equity includes 500$ of cash . So as per enterprise value method it's value would be 3000-500=2500$... doesn't it reduces the value of the firm, bcz i would get the cash for free in that case. It would be very helpful if you can clear this doubt.
I don't know what you are asking. You are effectively paying $2500 for the company in this case. The cash does not "reduce" the value of the firm, as extra cash boosts the company's Equity Value. So less Cash means you subtract less in the Enterprise Value formula, but that Equity Value is also lower.
Very well explained.. However, I have a small question with regards to the calculation of Enterprise Value (EV). As was rightly stated in the video, the EV calculation typically adds 'core' or 'operating' assets and subtracts the 'non-core' assets. Therefore, when calculating the EV, would it not make more sense to subtract only the 'extra' / 'free' cash that the company would not use for its growth and not the entire cash balance that a company has on its balance sheet?
Shashank Mallya Yes, it would. The issue is that most companies don't disclose the amount of cash that's required to run their businesses, so you can't really determine the amount of "extra" cash they have. So as a simplification and way to standardize the calculation, typically you subtract the entire cash balance in the Enterprise Value calculation.
Hey Brian, what do you mean with "VALUE to all investors"? I understand cashflow to all investors. The cashflow which pays the investors. (Net Income => Equity Investors ; EBITDA => Debt Investors) What is meant by value here? Maybe, I could understand that the equity investor owns the equity value. (Equity Value => value to equity investors) But how can a debt investor owns a company value?
It is the same concept as Unlevered Free Cash Flow being available to all investors, but this relates to capital structure rather than cash flow. "Value" just means how much of a company's capital structure each group represents. So if it's "Value to All Investors," you have to add up each components of a company's capital structure, i.e. Equity + Debt + Preferred Stock + Others, ideally using the market value for everything.
I was just unsure about one of the parts. I kind of understand how the market value of equity cannot be below $100 as shareholders will be paying less and receiving more. However, i don't understand how in a real life situation, if a ceo picks up $100, and puts in in the business, how does this translate to the change in the price or no. of share outstanding to account for that $100 increase?? Thanks, it was a great video.
The $100 would count as an Extraordinary Gain on the Income Statement. So, Net Income would increase by $100 (ignoring taxes), Cash would go up by $100, and the extra Net Income would flow into Equity and increase Retained Earnings by $100. It's like the company just earned free money for no particular reason.
Oh yes i understand how it increases on the financial statement, but how does the market cap (stock price x shares outstanding) increase by $100 as that is what needs to happen to offset the $100 increase in the EV formula? Thanks!
Because the company's Cash goes up by $100. Equity Value reflects the value of All Assets but only to equity investors. If All Assets increases by $100, and it was a result of something attributable to Equity Investors, Equity Value increases by $100 (so the company's stock price will increase).
minute 7, if a company has 500 cash no other assets, but 1000 debt it would make sense that the equity value would be below 500 having watched the last part: the enterprise value reflects what you have essentially paid for the company not what you should pay , so the actual value at which you buy the home increases, right?
JohnDot At minute 7 we are talking about the case where the company has no debt but $500 in cash. In that scenario, its shares could never be worth less than $500 total unless something very odd is going on. Enterprise Value reflects the value of the core business or the core property for real estate. So it only increases if something intrinsic about one of those improves - a renovation, more space, higher profits or revenue, higher growth, etc. The point is that it should not change simply because the cash, debt, or other parts of the capital structure have changed.
Mergers & Inquisitions / Breaking Into Wall Street thank you for your quick reply, however you didnt answer the last part of my post, i get that thingy with the core value, however, is the enterprise value the price you should pay for a company or not? as far as i understood it isnt, because you buy the whole company and dont carve out only the core business
JohnDot The Enterprise Value represents the effective price you pay for a company if you "take" that company's cash for yourself afterward and also repay its debt and other debt-like liabilities. So yes, assuming you buy the entire company, the Enterprise Value represents the effective price you should pay.
Thanks a lot for the video. I did'nt realy understood your first example, if a company has 500$ in cash that was generated out of a 400$ loan from the bank, this means that the Equity value is worth 100$ and not at least 500$, right?
The book value of Equity should be $100, yes, but the market value is different. The market value of Equity represents the value of all Assets but only to common equity investors... so if the company's only Asset is $500 in Cash, the market value of Equity should be at least that much.
harino45 The market cap should go up, yes. Equity Value should already reflect the company's entire cash balance. It may not immediately go up by $100 if the company has an extra $100 in cash, but it should, in theory, increase by that amount eventually.
Mergers & Inquisitions / Breaking Into Wall Street Thanks for the reply. But if market cap doesn't go up by $100 immediately, wouldn't that mean EV actually goes down a little because the extra $100 is fully subtracted?
harino45 Yes, potentially. But this is intended for use in response to an interview question, and doesn't necessarily reflect exactly what happens in real life the moment the company collects the extra cash.
What would happen if a company pays out dividend with cash on its hand? Would the Enterprise value remain the same as both cash balance and equity value decreases?
![Equity Value and Enterprise Value Interview Questions: What to Expect [REVISED]](/img/n.gif)
The analogy of finding an additional room vs $100 bill in the house on sale is so much clarifying. That you for this video.
Thanks, glad to hear it!
This is amazing - I am so happy to see this video, it considers all the relevant questions again and again, time after time, Thanks a lot!
Thanks for watching!
I was puzzled for a few second but then reverted back to accounting: increased the cash balance like that will simultaneously increase equity. Then, going back to the EV formula, the increased equity will be balanced out by the subtraction of cash. I saw it later in the video.
Александр Вальцев Yes, that is exactly correct. Increasing the cash balance should, in theory, also increase the company's Equity Value since Equity Value reflects the value of everything the company has. And then the increased Equity is balanced by the subtraction of cash in the Enterprise Value formula.
@@financialmodeling Why should we deduct non-operating assets? Let's say we have an operating asset on balance sheet, the value of which is estimated by the DCF model and also we have on the balance sheet is not an operating asset (for example, real estate). So if EV is the value of a company's core business, why should we deduct the value of non-operating asset? There is no sense. Non-operating assets have no relation with core business. We have to add them up to get the value of the whole company.
@@Dmitry-dy9yi Um, you do add non-core or non-operating assets to get the value of the entire company. That's what happens at the end of a DCF when you move from Implied Enterprise Value to Implied Equity Value. But the point is that you can only *pair* All Assets with Equity Value, and you can only *pair* Core Operating Assets with Enterprise Value. No one is arguing that non-operating assets are worthless; it's just an issue of which set of Assets you pair with which metric.
Great as always
Thanks for watching!
What would happen to the EV if the company takes on debt $2m and invest that cash in a project with a NPV of $3m? Thanks for your sharing, your points are well thought!
Depends on how the project is recorded on the Assets side. If it's recorded at its Book Value of $2 million, Enterprise Value increases by $2 million because Net Operating Assets go up by $2 million. If it's later revised up to $3 million, Enterprise Value increases by $3 million instead.
Sir, i have a little doubt, let's say I am gonna purchase a company having ,equity of 2000$, debt of 1000$, equity includes 500$ of cash . So as per enterprise value method it's value would be 3000-500=2500$... doesn't it reduces the value of the firm, bcz i would get the cash for free in that case. It would be very helpful if you can clear this doubt.
I don't know what you are asking. You are effectively paying $2500 for the company in this case. The cash does not "reduce" the value of the firm, as extra cash boosts the company's Equity Value. So less Cash means you subtract less in the Enterprise Value formula, but that Equity Value is also lower.
Very well explained.. However, I have a small question with regards to the calculation of Enterprise Value (EV). As was rightly stated in the video, the EV calculation typically adds 'core' or 'operating' assets and subtracts the 'non-core' assets. Therefore, when calculating the EV, would it not make more sense to subtract only the 'extra' / 'free' cash that the company would not use for its growth and not the entire cash balance that a company has on its balance sheet?
Shashank Mallya Yes, it would. The issue is that most companies don't disclose the amount of cash that's required to run their businesses, so you can't really determine the amount of "extra" cash they have. So as a simplification and way to standardize the calculation, typically you subtract the entire cash balance in the Enterprise Value calculation.
Hey Brian,
what do you mean with "VALUE to all investors"?
I understand cashflow to all investors. The cashflow which pays the investors. (Net Income => Equity Investors ; EBITDA => Debt Investors)
What is meant by value here?
Maybe, I could understand that the equity investor owns the equity value. (Equity Value => value to equity investors)
But how can a debt investor owns a company value?
It is the same concept as Unlevered Free Cash Flow being available to all investors, but this relates to capital structure rather than cash flow. "Value" just means how much of a company's capital structure each group represents. So if it's "Value to All Investors," you have to add up each components of a company's capital structure, i.e. Equity + Debt + Preferred Stock + Others, ideally using the market value for everything.
Thank you!
I was just unsure about one of the parts. I kind of understand how the market value of equity cannot be below $100 as shareholders will be paying less and receiving more. However, i don't understand how in a real life situation, if a ceo picks up $100, and puts in in the business, how does this translate to the change in the price or no. of share outstanding to account for that $100 increase?? Thanks, it was a great video.
The $100 would count as an Extraordinary Gain on the Income Statement. So, Net Income would increase by $100 (ignoring taxes), Cash would go up by $100, and the extra Net Income would flow into Equity and increase Retained Earnings by $100. It's like the company just earned free money for no particular reason.
Oh yes i understand how it increases on the financial statement, but how does the market cap (stock price x shares outstanding) increase by $100 as that is what needs to happen to offset the $100 increase in the EV formula?
Thanks!
Because the company's Cash goes up by $100. Equity Value reflects the value of All Assets but only to equity investors. If All Assets increases by $100, and it was a result of something attributable to Equity Investors, Equity Value increases by $100 (so the company's stock price will increase).
minute 7, if a company has 500 cash no other assets, but 1000 debt it would make sense that the equity value would be below 500
having watched the last part: the enterprise value reflects what you have essentially paid for the company not what you should pay , so the actual value at which you buy the home increases, right?
JohnDot At minute 7 we are talking about the case where the company has no debt but $500 in cash. In that scenario, its shares could never be worth less than $500 total unless something very odd is going on.
Enterprise Value reflects the value of the core business or the core property for real estate. So it only increases if something intrinsic about one of those improves - a renovation, more space, higher profits or revenue, higher growth, etc. The point is that it should not change simply because the cash, debt, or other parts of the capital structure have changed.
Mergers & Inquisitions / Breaking Into Wall Street thank you for your quick reply, however you didnt answer the last part of my post, i get that thingy with the core value, however, is the enterprise value the price you should pay for a company or not? as far as i understood it isnt, because you buy the whole company and dont carve out only the core business
JohnDot The Enterprise Value represents the effective price you pay for a company if you "take" that company's cash for yourself afterward and also repay its debt and other debt-like liabilities. So yes, assuming you buy the entire company, the Enterprise Value represents the effective price you should pay.
Thanks a lot for the video. I did'nt realy understood your first example, if a company has 500$ in cash that was generated out of a 400$ loan from the bank, this means that the Equity value is worth 100$ and not at least 500$, right?
The book value of Equity should be $100, yes, but the market value is different. The market value of Equity represents the value of all Assets but only to common equity investors... so if the company's only Asset is $500 in Cash, the market value of Equity should be at least that much.
But which part specifically of equity value would mathematically account for the extra $100? Would its market cap go up by $100?
harino45 The market cap should go up, yes. Equity Value should already reflect the company's entire cash balance. It may not immediately go up by $100 if the company has an extra $100 in cash, but it should, in theory, increase by that amount eventually.
Mergers & Inquisitions / Breaking Into Wall Street Thanks for the reply. But if market cap doesn't go up by $100 immediately, wouldn't that mean EV actually goes down a little because the extra $100 is fully subtracted?
harino45 Yes, potentially. But this is intended for use in response to an interview question, and doesn't necessarily reflect exactly what happens in real life the moment the company collects the extra cash.
Whtat happens in a theoretical case when the CEO picks up $1M of cash on the ground and the company's EV is $0.5M? Will the EV still be $0.5M?
Yes. Equity Value would increase, and so would Cash, so they would offset each other, and Enterprise Value would stay the same.
What would happen if a company pays out dividend with cash on its hand? Would the Enterprise value remain the same as both cash balance and equity value decreases?
Yes.