Hi everyone
Could someone please explain why to derive equity value, we add net debt ( LT,ST borrowings + notes payable - cash & equivalents) in some instances and deduct market debt in other instances? Specifically what is the relationship between the two that enables us to use the two ( net debt vs market debt) interchangeably to get the same result ( equity value of the firm).
Thanks!
can you give specific examples of any problems of curriculum?
As an example:
If you refer to the Equity Topic Test ‘Yee’, the case states that the company made 2013 FCFF will be $600 million and beyond 2013, FCFF will grow in perpetuity at 4% annually. The market value and book value of McLaughlin’s long-term debt are approximately equal and the BV of LT debt (in 2012) was 2249. The WACC is 9%.
The solution for this is therefore,
Firm Value = 600/(0.09-0.04) = 12,000
Equity value = Firm value – Market value of debt = 12,000 – 2,249 = $9,751 million.
If you look at the curriculum question on Holt Corporation (the last item set question on Reading 35 Free Cash Flow Valuation ), we are given the Balance sheet which shows LT Debt of 1575 (2008) & 1515 (2007) and Notes Payable of 465 (2008) and 450 (2007). The net borrowing therefore is (465-450) + (1575-1515) = 75 and this 75Mn is then added to FCFF (adjusted for after tax interest) to derive FCFE.
Is it correct then to say that:
i ) If Net Debt = (LT + ST Debt – Cash), You can derive FCFE by adding net debt to adjusted FCFF
ii) if Net Borrowings = (issued debt-paid debt) or the (change in Debt over the year), you can derive FCFE by adding net borrowings to adjusted FCFF
iii) if the market value of LT debt = the Book value of market debt, you can derive FCFC by deducting this from the Firm value?
Am a little confused by the logic as I don’t see the relationship between these.
i ) If Net Debt = (LT + ST Debt – Cash), You can derive FCFE by adding net debt to adjusted FCFF. - NO. FCFE = FCFF -A/T Interest + NET BORROWING. Not net debt. That has nothing to do with this.
ii) if Net Borrowings = (issued debt-paid debt) or the (change in Debt over the year), you can derive FCFE by adding net borrowings to adjusted FCFF - Correct. See above.
iii) if the market value of LT debt = the Book value of market debt, you can derive FCFC by deducting this from the Firm value? - Not sure what FCFC is or “Book value of market debt” is. Calculating the value of the firm and FCFE are two totally different concepts. Value of firm’s equity = FCFF1/(r-g) - Market/Book value of debt. FCFE is still FCFF -A/T Interest + NET BORROWING. I guess I’m not really sure what you are asking here.
I think you might be confusing Free Cash Flow in and of itself with valuation as bfry said. You add back net borrowing as it is available to free cash flow to equity holders. But if you had the value of a firm (NOT FCF but actual value) it includes the value of equity and debt. So the VALUE of the equity takes off the debt.
sorry, FCFc was a typo ( I meant FCFF) and I meant book value of debt ( market debt was a typo again)!! So, firm value is the enterprise value? And, since EV=mkt cap+debt - cash, to isolate equity value ( i.e. Market cap) we deduct net debt ( i.e.: debt - cash) from EV ( aka firm value)? Thanks !