Enterprise Value Interview Question
Let's say a company’s current share price is $20.00. It has 10 million shares and 1 million options with an exercise price of $10.00. What is its Diluted Equity Value? How does the enterprise value change?
I undersatnd using the TSM that 500,000 new shares get created ($10M / $20) so the new equity value is 210 million. Also, there should be no change to enterprise value since there is no change to core operating assets. But using the formula EV=Equity Value+Liabilities to other parties − Non-operating Assets, how do you justify that EV is unchanged? Equity value goes up by $10 million (after using the cash to buy back shares thru TSM), so what brings it back down so EV is net zero?
Would love some insight.
Equity value does not change. The share price should decrease to account for the greater number of shares
Think of the following steps for the treasury stock method:
1. Company receives $10mm cash from issuing 1mm shares at $10/sh from the options. Cash and equity value increase by $10mm
2. Company uses the $10mm to buy back 500k shares at $20/sh. Cash and equity value decrease by $10mm
As a result, there’s no net change in equity value or cash, but the share count has increased by 500k. The share price should decrease to ~$19.04 ($200mm/10.5mm), leaving EV unchanged
EQV most certainly changes. You don’t adjust the share price solving for it with the OG EQV and additional shares outstanding. That defeats the whole purpose of calculating what EQV is…diluted. Company receives 1Mx$10=$10M from the issuance of shares following the exercise of calls as you described. Note that 1M additional shares are created here. At this point, equity value increases by 1Mx$20=$20M. The company then buys back $10M/$20 = 500K shares, making net dilution 1M-500K = 500K shares. Now, equity value decreases by 500K*$20=$10M. The net change in EQV is thus $20M-$10M=$10M.
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