Received this question in an informational interview:
$100m company sells division for $10m (fair market value). What happens to EV? What happens to Equity Value?
Was told the EV stays the same - Cash replaces the division that was sold. Equity value goes down.
Can someone please explain this?
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Equity value should not go down here.
Theoretically: Think of EV as the value of the operating assets of the business. Since you sold $10m worth of them, EV goes down by $10m. In turn, cash goes up by $10, and equity/debt value stay the same since everything was done at fair value.
Mathematically: Cash goes up by $10m due to the sale. Equity value and debt value should remain the same. Since cash goes up by $10m, EV decreases by $10m.
might sound really stupid but could you explain why you subtract cash from enterprise value?
EDIT: is it because if EV represents a potential takeover price, the acquirer would essentially be getting those cash reserves so you reduce them from the price
That's one way to look at it. Also, you can think of it as you are making the strategic decision to hold the cash instead of using it to pay off equity/debt.
@monkeytomd" you would subtract cash from enterprise value because cash is not an operating asset. You do not need to deploy all your cash in hand to operate your day-to-day operations.
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You basically strip out part of the free cash flow from your DCF (the division you sold). Therefore EV goes down from 100 to 90 (with 100 equity value assuming no debt). Since you received cash for the unit, equity value will remain at 100 (90 + 10 assuming no debt).
You usually say that transactions, and in turn, valuations, are done on a cash-free, debt-free basis, which is why equity value goes up by 10 and enterprise value goes down by 10.
EDIT: You could also look at it from a buyer's perspective.
You are buying this business that has an enterprise value of 100m. However, right before the transaction the owners (equity holders) sell off a division for 10m. A rational buyer would demand enterprise value to be reduced with the 10m, which would imply an EV of 90m. The 10m from the sale is with the equity holders.
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Lol my bad, you’re absolutely correct. Equity stays the same.
You got this question in a networking call? Was he trying to grill you?
Goes to show how much interviewers themselves know...
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