I've recently had a series ofquestions thrown at me during one interview and wanted your opinion whether I've answered them correctly... They all had to do with what happens to enterprise value when you issue new equity or debt. The questions were:
If the current EV of a company is US$500mm, (= US$300mm, net debt = US$200mm, other EV items assumed to be zero) what happens to EV when...
1) ...the company issues US$200mm in new equity?
2) ...the company issues US$200mm in new equity which US$100mm will be used to pay out as dividends to shareholders?
3) ...the company issues US$200mm in new equity which will be used to invest in a business worth US$100mm?
4) Please answer the above if US$200mm in new DEBT is raised (assuming TAX FREE world).
5) What would happen to question 4 if taxes are now involved?
I answered as below:
1) EV is still US$500mm because the US$200mm in new equity will offset US$200mm increase in cash
2) EV is now US$600mm because there is a net increase of US$100mm in equity (US$200mm in new equity minus US$100mm in dividend payout in cash)
3) EV is now US$700mm because the US$200mm cash raised through the equity will be offset by the purchase price of US$100mm (paid in cash) and gain in EV by US$100mm. Effectively, you have US$200mm in new equity, US$100mm in investments and US$100mm in cash remaining.
4) Exactly the same answers as the issuance of new equity answers
5) Didn't know how to answer this one properly ...
Any thoughts as to whether I answered the above correctly?