The question is the following : What is the impact of a $100 loan on the EV ? If i use this cash to buy a fixed asset ?
For the first part, one can just say that EV = Net Debt + EqV. If Debt + 100, Cash +100 so the Net Debt variation is 0. No impact on EV.
However, I'm a bit confused for the second one. If I use all the cash, Net Debt is +100 so EV = +100 ?
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Not exactly. Think about what happens to both sides of the balance sheet when you make a purchase.
+100 on the asset side (if you purchase a fixed asset like you said) and +100 on the liability side (if you funded the acquisition with debt), so your net debt goes up +100, so EV goes up +100
If you only used cash on hand (no debt) to fund the acquisition, then there is no impact to EV because it would be +100 on the fixed asset and -100 on the cash, which is a net 0 impact to total assets and doesn't impact the liabilities or equities side of the balance sheet.
Second statement is not fully right.
EV is the value of the net operating assets of the firm. If the $100 was excess cash on the balance sheet (so a “nonoperating asset”) and you bought PPE or something then you’re essentially converting $100 of nonoperating asset to an operating asset so EV or net operating assets go up by a $100.
Congrats, you found the 1 caveat to my statement. OP is confused, and throwing edge cases at him/her isn't going to help them understand the concept.
It’s not an edge case but the definition of enterprise value…
Easy analyst. You sound like a nerd with no business experience, and as such not qualified to opine on matters like these.
Think you were correct Oil and gas. Stay strong
Actually I think you’re fundamentally and clearly incorrect. EV is basically the market value of a company’s operating assets. That’s what you’re solving for with the formula.
Using excess cash (a non-operating asset) to purchase PP&E (an operating asset) increases your EV by that amount.
I think you are confusing the matter, the EV is the free cash flow of the firm in theory. If those assets generate more cash than maybe EV increases at some point in the future but under current circumstances and given the information provided, one can not make a defensible argument that these two corporate transactions impact EV in any way. It is simple
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How would increase in fixed assets increase EV?
It wouldn’t unless the asset proves to be more valuable than the price at which you purchased it, which would not be a conservative or defensible assumption in most cases when dealing with sophisticated investors
This is not right. The EV will go up by the PV of the cash flows generated by the purchased asset. If the PV is $100 -- i.e., equal to the price paid for the asset in this example -- then EV will go up by +$100. If the PV is $50, then EV will go up by +$50. If the PV is $0, then EV will remain the same.
Here is an example to help further clarify:
Let's say that you have a business that generates $100 a year in FCF into perpetuity. At a 10% discount rate, the EV of the business is $1000 (=$100/10%). Now, let's say that you borrow $100 but leave the proceeds in cash. The FCF of the business is still $100 a year so the EV remains unchanged at $1000 (=$100/10%). Now, let's say that you take the $100 in cash and purchase a widget that helps your business generate an incremental $10 a year in FCF into perpetuity. Now, the business generates $110 a year in FCF into perpetuity. The EV of the business is now $1100 ($110/10%). Therefore, the EV of the business goes up by PV of the cash flows generated by the purchased asset (in this case, $100).
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Hey guys, there is no "right or wrong" in my view. If the candidate were to answer this using examples like you have hominem and AN1, they would definitely pass the acid test and maybe get bonus points as you have shown the ability to demonstrate concepts using examples and nothing you have said is technically incorrect. The nature of this question is that of arguments and reasoning skills, not arithmetic computational ability. We have excel for that. This is of course my perspective guys, but I do not think it is productive or helpful to say that someone is flat out wrong because their answer does not exactly match the one you provided. AN1 first started by saying that EV +100 with conviction, and then went on to provide an example where EV could actually decrease by -50; so how can you say that anyone is right or wrong when you have already shown that there can be more than one reasonable answer to the question?
Hominem, to directly address your argument, how do you know that the asset in question will produce any cash flows? Is there any textual reference to the cash flow production of the purchased fixed asset? What is your basis to be so confident that EV will certainly go up? Does it not depend on the quality of that asset, if it is indeed one that produces cash flows? What in the OP leads you to the conclusion that the fixed asset will generate cash flows? Are you not sure that this is a corporate data center for IT infrastructure, and thus an overall expense burden and cash flow drain on the business?
Also, to clarify, the PV of $100 cash on the balance sheet is $100. if you shift this from cash to a fixed asset the balance sheet would remain unchanged. But enterprise value cannot be found on balance sheets last time i checked.
Easy way to think about it is if your net operating assets change, then your EV will. Eg: you take 100 of debt - there is no change to net assets so no impact on EV (as you said +100 debt and +100 cash will net out) If you use that 100 debt to buy an asset such as inventory, your net operating assets increase and so does your EV (+100 debt and +100 cash, then -100 cash and +100 inventory). Cash is not an operating asset but inventory is
EV is free cash flows discounted to present . Keep it simple. This is a tough question though and understandable that many might over think it
Should not impact EV plain and simple. EV is independent of capital structure; unless the fixed asset you bought turns out to be dog shit and management proves to be poor capital allocators, which more often than not is likely the case as people buy shitty assets at the behest of persuasive bankers and/or salesman who sold the fixed asset quite often from what I’ve seen. Once again, this field requires judgment and moreover business does not always follow a formula as Damodaran seems to believe. I digress…
To see the distinction between different measures of value, let's go to the balance sheet format, with market values replacing accounting book values.
Cash and other non operating assets + { Operating assets + Intangible assets + Working Capital } = Debt + Equity
So, Enterprise value = { Operating assets + Intangible assets + Working Capital } = Debt + Equity - Cash and other non operating assets
For 1st case, things get cancelled out in right hand side itself.
For 2nd case, Operating assets increase (Gross debt increases) and hence Enterprise value increases. But you have to assume hat those assets that you bought will increase your future cashflows.
There is no black and white answer here, from valuation perspective you need to know the value that asset creates and from an accountant's perspective - it increases EV.
Well said, though I would add that “EV” is not a recognized measurement under generally accepted accounting principles in the United States. Not being a smart ass or anything as I think you are hitting the mark well in distinguishing the accounting perspective from the financial valuation perspective. In accounting, things are black and white in order to comply with GAAP or IRFS if international, and thus an equation would suffice to answer the question posed by the young analyst who posted this - that is, if we are to assume the perspective of an accountant. However, in investment banking and finance generally the key issue is value and how that can best be measured and analyzed — this of course is an inherently non-rules based line of thinking. While the rules and formulas are helpful in thinking about value, I think they should be viewed just as they - a helpful guidepost. To become to rigid and stiff is to lose touch with reality and the market: and the best investment bankers are typically those who are in touch with the market and the sophisticated institutional investor universe. Nonetheless, think you brought up a great point and helpful way of thinking about this.
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