Technical question: EV/EBITDA
Saw this on a technical guide
Company H is a supermarket chain. Company H recently discovered and took possession of an authentic Leonard DaVinci painting inside the supermarket. How does this affect Company H’s EV/EBITDA multiple? How does this affect Company H’s P/E multiple?
Answer: EV/EBITDA doesn’t change but P/E goes up
My thinking:
Equity value goes up bc Company H’s total assets should go up so shareholder’s equity would increase to balance the BS
However enterprise value stays the same bc equity value is up but cash and cash equivalents (the painting) is also up?
i basically agree. the painting isnt an operating asset, so you back it out of enterprise value. as you note, this would increase equity vaue and push p/e higher.
the real issue here is that some dumbass gave the painting to the store instead of immediately selling it to southeby’s
Enterprise value is determined by the future cash flows generated by the supermarkets.
Unless you can assume that there is a probability that each supermarket generates occasionally a cool painting, the cash flows of the supermarkets remain the same.
The only difference is an additional liquid(ish) asset that the company can monetize for cash. This doesn’t affect the value of the operating asdets
Currently reading the guides too - my thinking is as follows:
(1) EV remains the same since the painting is considered a non-operating asset. EV is equivalent to net operating assets since it represents value to all claimants (debt and equity). Mathematically, equity value rises (because unlike EV, equity value measures net assets less total debt and other liabilities) but is offset by an increase of the same magnitude in non-operating assets, causing EV to stay the same
(2) Wouldn't current EBITDA increase by the asset amount, since we need to record a long-term asset account and an equivalent revenue figure on the IS?
(3) P/E should be higher since EqVal is up. But I'm guessing that current earnings are up to for the same reason current EBITDA?
Would it be fair to say that if we're using current EBITDA and earnings - EV/EBITDA and P/E will fall (but not as drastically) since both denominators are higher from the asset revenue?
Forward multiples should be moot since this revenue is non-recurring (and you obviously can make the case that markets are forward looking and so there's a mismatch in the numerator being forward looking and the denominator being current/backward looking)
I think you’re broadly right but why would you assume cash flows will increase given it doesn’t state the painting is sold?
Since they just gained an asset and not actually disposed of it for cash I would think it would just be P/E up and EV / EBITDA remain unchanged.
could very much be wrong here but I viewed it similar to a donation, where upon discovering you debit the asset account and credit revenue (I think it's called contribution revenue?)
EBITDA and NI goes up in the interim because of this, but cash flow stays constant since the revenue is non-cash and needs to be backed out in the CFS
when the asset is sold then you'd either record a gain or loss depending on whether sale proceeds are > or < than book value, while making the necessary adjustments in the CFS
all theoretical and think the most practical answer to an unpractical question is that company sells painting and reinvests into operating assets, causing both EV and EquityVal to go up
these questions are retard #1. on paper, you’re answer is right #2. but in practice (#3) if a company freely acquires an asset with value, then it is inherently more valuable and thus market cap should go up, positively affecting ev (thus increasing ev / ebitda).
follow up: question is static vs fluid. too many people are thinking about bridging market cap to ev. think about how companies are actually valued on an equity basis.
I'll preface this by saying that this is a brutal question and I'll hate the interviewer's guts if this gets asked.I took a quick accounting refresher dive and here's what I came up with.
There's a few important assumption here.
(A) The painting hasn't been sold
(B) Interviewer isn't asking asking for forward P/E or P/E as calculated for valuation purposes (e.g. considering MVE vs. book value of equity). This is referring to accounting P/E calculated as Share Price / EPSWith this in mind, this is how I would think about it
Note that there's no accounting guidance discussing this topic and you are encouraged under both GAAP and IFRS to follow other applicable standards. Thus, I'm choosing to treat the asset as a gift and go from there.
(i) Gifts received with no exchanged consideration are recorded at fair market value on the balance sheet under Fixed Assets (debit) and a balancing entry (credit) is made under "Contribution Revenue" in the IS
(ia) Contribution revenue doesn't need to be recognized if the asset in question is a work of art with historical significance that meets certain criteria, such as held for exhibition and other educational purposes. Let's assume this painting will be used for capital appreciation (e.g. asset-held-for-sale in BS)
(ib) There are other capitalization / depreciation considerations, but this asset will likely need to be depreciated. However, the useful life is so long that the depreciation amount will be de minimis
Let's assume that the nature of the requires the recognition of contribution revenue and look at the impact of the asset on the financial statements.
Income Statement
-"Other revenue" would increase by the fair value of the asset. Note this would appear after Operating Income
-Net Income" would increase by the after tax value of the asset
-“EBITDA" would not be impacted as this is (i) a non-cash transaction and (ii) even if it wasn't, we generally look at Adj. EBITDA given that this is a one time change so any incremental revenue would be subtracted
Balance Sheet
-"Non-current assets" maybe "Assets-held-for-sale" would increase by the fair value of the painting
-"Stockholders Equity" would increase by the value of the painting less the decrease in cash and cash equivalent
-"Cash and Cash Equivalents" decreases by the tax amount
Cash Flow Statement
-Net income will be adjusted for the contribution revenue amount as this is a non-cash transaction
-Ending cash balance will decrease by the tax amount paid for the incremental "contribution revenue amount" (e.g. fair value of the painting)
All in all, your operating assets (despite the slight decrease in ending cash) and liabilities remain the same. Thus EV should not change much (maybe a slight increase resulting from the tax payment)
EBITDA on an adjusted basis remains the same.
Book Value of Equity increases by the fair value of the asset less the change in cash (i.e. tax outlay). Which will lead to:
EV/EBITDA - unchanged / decreases (assuming no tax impact it remains unchanged, accounting for the tax impact it should increase as your net debt will higher. Reasoning here is the following, EV can also be calculated as follows Equity Value - Non-Operating Assets + Liabilities + Equity representing other non-common investor groups. This gets you to the formula we are all used to seeing. But expanding on the above Non-Operating Assets increases by Painting - Change in Cash, and in theory so should Equity Value netting no overall delta, though we don’t know how the market will react and Equity Value may actually increase)
P/E - unchanged / increases. Stockholders Equity increases by the same amount as Net Income, so EPS or NI / SE is the same (assuming no change in share price). If we assumed no contribution revenue, P/E multiple will increase as your NI will stay the same and SE will increase.
EDIT: Expanded on my conclusion and rationale. Lots of moving parts here. Bottom line is answer to this question will vary depending on whatever assumptions you decide to make. When interviewing make sure to keep your assumptions simple while actually understanding how things would flow if you tweak your assumptions.
Expanding on my last point. If liquidating this asset has a meaningful / outsized impact on the business and shares trade up. MVE will increase and so will EV. Also there might be a small increase in EV regardless resulting from the increase in net debt (as ending cash is lower from tax impact).
Just a weird question overall. I think the answer provided to OP is an oversimplification to what's actually a very complex accounting problem and it also assumes that no revenue for the asset is recorded.
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