Enterprise value

CFA Level II
#1

Why do we remove cash and equivalents when calculating EV? As in - surely the market has accounted for that it in its estimate of the market value of equity or debt? Why cash but not say PP&E therefore?

Thanks a lot

#2

If you paid for the value including cash and cash equivalents you could use that cash and equivalents to payoff debt, so it makes sense to remove it from the EV. Also, it would be equivalent to this: You pay me 100 dollars I give you running shoes (70 dollars) and I give you 30 dollars cash. Total values exchanged are the same, but the effective transaction was for 70 dollars of goods (running shoes). We might as well both keep our extra 30 dollars, since exchanging it doesn’t do anything for anyone. (Pretty simplistic example)

#3

The common example is that you buy a wallet on e-bay for $50. When you receive it, you find 20 in cash in the wallet.

In essence, you paid $30 for the wallet.

#4

Thanks but in terms of using the cash to pay off the debt, I could also sell a factory or whatever?

And S2000 - surely it’s more like you sell me a $30 wallet for $50 cause we both know there’s $20 in it - but our acceptance of the $50 price depends on that $20 being in the wallet?

I suppose I don’t understand why cash is treated differently to any of the other elements that make up the value of the company.

Appreciate the responses - thanks

#5

Of course it is.

Nevertheless, you paid $30 for the wallet.

You’re quite welcome.

#6

Dear jackhickey1981

Intuitively, EV is the value of Operating assets of the company So in the balance sheet you have operating assets such as PPE, AR, etc and non-operating assets such as cash and marketable securities. So When you value a company, it is market value of Debt + Market Value of Equity on the liability side of the balance sheet which is equal to the Market value of operating assets + Non operating assets If you Subtract the value of non-operating assets from the market value of Debt and Equity, that gives you the market value of operating assets which is also called Enterprise Value. Thanks

#7

You can think from other way around.Because you’re acquiring Debt of the Company as well, essentially you’re acquiring a liability. So when you’ve acquired the Company, you can use that Company’s cash to pay off Debt. This is called Net Debt (Debt adjusted for Cash). So essentially, you acquired less debt and that is adjusted in your enterprise value calculation. Not sure if i explained it correctly (its 1.30 am now).

#8

Thanks all

#9

My pleasure.