EV = MV common shares + MV debt + MV preferred shares + minority interest - cash and investments Can someone explain why we must subtract the cash and investments in this equation?
Cash and investments reduce your cost if you were to buy the company so should be subtracted. In other words, if company A had $500k in cash sitting on their balance sheet, and B purchased company A. Company B would use this 500k to repay debt, reducing the overall cost of the acquisition by the amount of cash and investments.
It’s like getting a cash rebate when you buy stuff… If it costs $200 but you get $50 cash rebate you really only pay $150 for it.
Got it, thanks
cash rebate is defenately a good way to think about it.
After all stake holders get their money back , liquid investments belong to the buyer of the firm . So once debt is paid back and preferred get their money back and the equity of common stock holders is also redeemed , then anything left over can be used by the new owners. cash is a drag on the company , and this is why
I feel pretty mad at myself to not be able to understand this issue: As I understand, the value of a firm should equal to the market value of its equity (assets - liabilities) From the EV equation, why does an acquirer have to pay for the market value of debt of the acquired firm? For me, it’s like why you have to pay to own someone’s debt. Please clarify. Thanks in advance!
Dont confuse between Market value of Equity and the Enterprise Value, they are 2 different values. When you purchase a company by buying ALL its outstanding shares, you pay Market Value of Equity. But you still do not have 100% claim on all of its assets. Some of its assets still belong to debt holders. What you have bought is 100% control on its operations AND part of its asset claims. But Enterprise Value is the sum of value to ALL stakeholders. Does it help? Also, cash rebate example was good above. Another example could be, say you buy a vallet for $100, which already has $20 cash in it. Then the actual value of that vallet is $80 and not $100.
Just think of it this way… you don’t spend cash to buy cash from another firm.
rus1bus Wrote: ------------------------------------------------------- > Also, cash rebate example was good above. Another > example could be, say you buy a vallet for $100, > which already has $20 cash in it. Then the actual > value of that vallet is $80 and not $100. Freakin’ good example!
Thanks rus1bus. It makes a lot of sense!