How is non-operating/excess cash ususally handled in a transaction; i know it comes down to negotiations and working capital needs, etc. But can someone help clarify my thinking here…
Say you value a company and determine it’s operating value is $95mm and the company has $5mm in excess cash for a total COmpany value of $100mm. At the negotiating table you (the buyer) could be $100mm to the seller and keep the $5mm cash that’s on the balance sheet OR cut a check for $95mm and let the seller keep the $5mm cash on his way out. Is that generally how it goes, one or the other ?
I’m missing something though. In the first scenario you (the buyer) effectively pay $95mm bc you get to keep the cash (while the seller has $100mm in his pocket). In the second scenario, you effectively pay $95mm and the buyer has $100mm in his pocket (bc he gets to take the $5mm cash). I see how those line up but isn’t there a disconnect there, how are you paying $95 million while the buyer is walking away with $100mm ??? How’s he getting more than what you pay…ahhh, what am i overlooking.
I’m pretty sure the post relates directly to the reading titled “Market-Based Valuation: Price and Enterprise Value Multiples”, which is part of the curriculum. The book addresses adjusting for cash and short-term investments, the very point i’m asking about.
I don’t think the book presents a full example. I guess i was just thinking through the process myself and just assumed that i was overlooking something. The text clearly defines EV as equity + debt - cash, therefore EV must be less than invested capital (MVIC: debt + equity) by the cash amount.
However, if you were to actually think through the calculation of each with a DCF, it seems like the opposite is true. Becuase if you take cash out of WCInv then your incremental working capital adjustment is smaller bc working capital as a % of sales is now smaller. Bc you’re subtracting a smaller number, EV is greater than when you include cash in WCInv, which doesn’t make sense. EV should be less than MVIC by the cash amount.
When finding FCFF you make an adjustment for working capital (WCInv). The working capital considers the inclusion/exclusion of cash. When determining EV, you exclude cash from WCInv for each period in your forecast. The opposite for MVIC. If you exclude cash however (EV) you get a higher company value then if it was included. The book says that EV should be less than MViC bc cash is excluded but here, it’s higher…
whatever cash is available in the books of the company being purchased is the property of the buyer, once the deal goes thro. That is why it is excluded in the EV calculation. It is not the property of the seller. The buyer is free to do what he chooses with it, free and clear.
WCInv doesn’t include cash in the first place so there is no reason to take it out WCinv is changes in all current accounts except cash and near cash items, short term debt and the current portion of long term debt.