Company A has ND of 20 and EqV of 50, Company B has ND of 10 and EqV of 40. A buys B with 50% debt and 50% cash, what is the resulting EV and EqV of A?
In general, what is the right way of reasoning for these types of questions?
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and if the merger is all in cash or cash+debt does the mkt cap of buyer change?
Assuming no synergies:
Company A has starting EV of 70. Acquires 50 of EV, so pro forma EV is 120. The 50 of acquired EV are financed with 25 of debt and 25 of cash, so net debt increases by 50 [25-(-25)]. Removing pro-forma net debt to derive pro-forma EqV, this results in a pro-forma EqV of 70
I would have said EqV is the same with 70 of ND
I think you forgot to include the 20 of net debt that already existed. So your pro forma net debt is 70 resulting in no change in equity value.
Intuitively that makes sense. Were paying for an asset entirely with net debt (decrease in cash is the same as an increase in debt), so EqV doesn’t change because the increase in TEV is offset by the increase in net debt.
other way to think about it is that if we’re not issuing new shares, EqV shouldn’t change, or else we’d be adding shareholder value from nothing. If we start talking about paying for the asset with stock, then EqV could change.
thanks
I would have said EqV is the same with 70 of ND
Move along with the formula of EV = EqV + ND
Company A buys a $40 equity of B with 20 cash and 20 debt.
EqV 50 + 20 A's old debt -(-20) cash + 20 new debt + 10 B's debt = 120.
On the other side the sum of the productive assets after the merger would be the sum of two EVs 70+50 = 120.
The debt/cash composition of the M&A financing doesn't affect the EV. Just put different cash/debt compositions in the formula above. But fundamentally it's because it will be the same productive assets of companies A and B combined.
Equity value will change subsequently if the assets generate more value than paid or if the debt will amortise faster than assets will depreciate.
Equity will change subsequently if the debt will amortise faster than the assets will depreciate.
And yes, we ignore the equity value of company B, because B's owners basically were substituted by other investors.
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