Does capital structure affect TEV? CONFUSION
I can see in the TEV = Equity + Debt - Cash formula that any shift from one area of the capital structure to another has no net effect on TEV. For instance, if we increase debt through a debt issuance, the effect on TEV is negated through the increased cash accounts. Same can be seen for a debt repayment, or a stock issuance/buyback.
However my intuitive understanding of TEV is that it is the PV of the future FCFF, which is discounted by WACC, which clearly changes depending on cap struc because of the interest tax shield and expected costs of financial distress.
SO DOES CAPITAL STRUCTURE AFFECT TEV OR NOT!?
Corporate finance is not an arithmetic equation lol. Capital structure definitely affects firm value - in your equation it affects the market value of equity, even though debt and cash offset each other.
You're spot on about interest tax shields and costs of financial distress. Other factors include agency costs and information asymmetry.
In theory...
http://en.wikipedia.org/wiki/Modigliani%E2%80%93Miller_theorem
Haha, remember though that MM assumes no taxes, no financial distress costs, symmetric information, frictionless markets, and no agency costs. Or in other words, a completely unrealistic world. There's a lot of empirical studies that have been done on capital structure - you can probably Google most of the academic papers out there.
Yea the big one there is assuming no tax shield for debt.
You can run a WACC analysis to try and figure out the optimal capital structure given spreads in the market at various rating levels (i.e. estimates increase in cost of debt based on higher leverage, which offsets tax shield benefit). At some point you reach minimum WACC (believe was around BBB in current environment for a company we looked at, around 2.5-3x leverage).
In the real world of auction processes, particularly where sponsors are buyers, it is often a driving factor when considering a bid price
If TEV is affected by capital structure, then how is TEV/EBITDA "capital structure neutral"?
It is not, however, most companies target an efficient capital structure to maximise their EV, so you will generally not differentiate between EV/Revenue, EV/EBITDA or EV/EBIT trading multiples on the basis of capital structure (unlike P/E). Three main drivers of EV/EBITDA multiples are: (i) top-line growth, (ii) return on capital (including margins and capital intensity), (iii) cost of capital (impacted by capital structure).
I'm still confused.
"Because EV is a capital structure-neutral metric, it is useful when comparing companies with diverse capital structures. Price/earnings ratios, for example, will be significantly more volatile in companies that are highly leveraged."
...How is this true, if capital structure does affect TEV...
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