Moelis interview Q - how much is a piece of debt worth if total debt outstanding > EV?

Going to take a crack at this. Tell me if I'm wrong, which i probably will be.

Here goes: EV from DCF is present value of unlevered cash flows to both debt and equity holders. Hence, if DCF Valuation is debt, then that would imply that not enough cash will be generated for debt holders, hence the debt will be valued less than par, which gives equity holders the put option to walk (theoretically, lenders are short a debt put, and equity holders/borrowers are long a debt put).

If the total firm value is less than the debt outstanding, then the debt effectively is worth at the very least nothing since the put option is exercised, or at the very most, worth the assets of the firm should the firm file for liquidation.

Those are my two cents. Thoughts?

^ I guess that makes sense. All that real options logic seems unnecessary though.

If the firm has more debt than its worth, than the debt is worth however much the firm is worth. Debtholders get paid first.

the way I see it is as follows: Enterprise Value Waterfall: original EV: $1,000, then: Senior Debt: $400 Mezzanine Debt: $200 Equity: $400

if EV falls to $500, then: Senior Debt $400 Mezzanine Debt: $100 Equity: $ -

Debt could be worth less than what the waterfall shows in a distress situation in which the Company needs to liquidate or restructure and pay off its suppliers, employees, etc. (which are higher ranked in the corp structure than anyone else - aside from lawyers haha).

Depending on whether the debt is secured or unsecured the debt should be worth roughly what the collateral is worth less claims from higher ranked parties (as mentioned above).

Hope that helps

I think the main point of the question is to see if you know debts have different seniority.

All good comments so far - the options discussion is relevant and in my mind would get you points in an interview - it's the reason why super out of the money debt and equity might still trade above zero (nuisance value is very real in restructurings).

It's a question that prompts you to ask more - you need to know more about the capital structure - junior debt will technically be worthless if you follow absolute priority and the EV doesn't cover senior claims - but in reality it's usually still of some value. It's a good question if you want to ask someone "what do you know about restructuring."

FYI for EV purposes a lot of times you'll just see the EBITDA capitalized - i.e. it's a $200 mm company, trades at 5x EV/EBITDA, and theres debt of $x mm/bn split between $y mm secured and $x-y mm unsecured, then they ask what do recoveries look like?

From a non-DCF perspective, one cannot answer this question without knowing the amount of cash on the balance sheet. EV is cost to acquirer, NOT the value of the firm. From a non-DCF perspective, EV can be very low (or even negative) if cash levels are high enough and the market cap ignores this. Market cap ignoring cash could be because of 1) temporary anomaly/undervaluation - in this case debt could be 2) poor future outlook for the company - in this case, value of debt is down to maturities and timing of sufficient cash flows to repay debt. From a DCF perspective, agree with the discussion till now that value of debt would depend on seniority/collaterals.