Why does a discounted cash flow approach yield Enterprise Value? Newbies GTFO
When looking at Enterprise Value in a market approach, it gives you sort of the "bare bones" total firm value. It doesn't include any cash because you'd basically be paying cash for cash.
But in an income approach model you model cash as a component of current assets. As a company grows in size, it needs more and more cash to perform its operations. Therefore the contribution to the cash account each year in a growing company is a "use" of funds. So the DCF model would NOT yield an enterprise value, and instead it would yield Enterprise Value + operating cash..so would it be MORE accurate to say that the DCF approach gives us Enterprise value + operating cash?
Or, would it be more accurate to subtract only EXCESS cash (instead of all cash) in the market approach when calculating EV?
Then is it more common to subtract total cash or leave in all cash when calculating EV?
If we leave all the cash in, more aggressive multiple. If we take all the cash out, more conservative multiple.
Excellent thread on this topic: //www.wallstreetoasis.com/forums/enterprise-value-and-minority-interest-1
But as long as your methodolgy is the same across the board it shouldn't matter.
Thank you!
look the best way to think about substracting cash when calculating EV is as follow. you know that Assets=E+L; cash is an asset and therefore it is inherently accounted for in either your debt or equity (market cap) FV calculation, hence you substract it cause if you dont, you would double count it.
To tack onto Oreos's comment, that excess cash is really the correct number you should back out to get to net debt, the right way to think about the business' required "operating cash" is to think of it as a component of the Net Working Capital. As the business grows, it will grow its NWC as it carries greater inventories and A/R (less A/P), and also will need more operating cash to grease the wheels. Sometimes you look at the industry-wide cash as a percentage of revenues to determine whether the subject company might be carrying excess cash that should be taken out of firm value.
Good question, OP. To play devil's advocate to re-ib-ny, there are also plenty of industries where industry-wide cash levels are deceiving. One of these industries is big pharma; almost all of them have multi-billions of dollars on their BSs (unless they just closed a transaction). To take this a step further, almost all of them have greater than 50% of their cash tied up in foreign countries, waiting to be repatriated (but it never will be. it will just sit there).
That's true too. So to combine what everyone has said so far: sometimes you'll look to industry norms to find "necessary operating cash," sometimes you'll make an educated guess, sometimes you'll treat all the cash as operating cash, and sometimes (probably most often) you'll just make a simplifying assumption and treat all the cash as excess cash. And this all goes back to Oreos original point: touted as correct but difficult to quantify.
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