A company finds a briefcase with $100,000 in cash, and it now belongs to them. What happens to the company's enterprise value, and why?
Please explain why the company's enterprise value does or does not increase. I appreciate any help!
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It seems that the company's enterprise value would decrease. Market value of equity+debt-cash and cash equivalents=EV. Because you subtract the market value of cash and cash equivalents from MV of equity to arrive at enterprise value.
Initially the EV would decrease and as finance bro says equity value will likely be bid up in the future returning EV to its beginning value, tricky question depending on what the interviewer wants
EV stays the same. $100,000 cash causes Equity value to increase by 100k but is offset by subtracting 100k cash or the decrease in net debt, so there is no change to EV.
Amazing how many wrong answers there are..
Why does it make Equity Value increase?
Is it because all cash is assumed to flow to the shareholders?
Of course. The shareholders own the assets of the business, less its liabilities. Any time you increase an asset without an offsetting liability, you increase equity value. A = L + E.
If you're looking through the lens of discounted cash flows to determine equity value, consider this a one-time flow of $100k at time=0.
All valid points, but intuitively, why would you pay the same as a buyer for a company that is sitting on more cash? That would be a bargain no matter how you put it... can't be right
You wouldn't be. If initially the Company had an Equity Value of $500k, Debt of $250k, Cash of $150k, and therefore an Enterprise value of $600k. If the Company has 100k shares outstanding then it's trading at $5.00/share.
Now you find the briefcase of $100k and consider it additional paid-in capital (Debt Cash, Credit Additional Paid-In Capital). Now you have Equity Value $600k, Debt of $250k, Cash of $250k, and there an Enterprise value still of $600k. Now though the price/share you have to pay for one of the 100k shares is $6.00/share.
That is at least my best guess.
You wouldn't. If the cash is included in the transaction, then it would bid up the purchase consideration. Usually, however, excess cash isn't included. It's distributed prior to the sale.
I would think about the rationale before worrying about the formula. You subtract cash because, yes, it is a non-operating asset but also because it is implicitly included in equity value. If equity value goes up by $100k because of cash and you subtract out the $100k in additional cash, then you're always left in a neutral position. (The situation would be different if some of the cash goes towards working capital requirements)
What are the tax implications of "finding" $100k? Can you just accept the cash?
For the purposes of the question, this doesn't matter as the question asks for the immediate effect on EV. But my understanding is the cash has to be recognized on the income statement, probably under non-operating income, so you would need to look at the after-tax effect of the income.
Then wouldn't the immediate impact be the after-tax cash, not the full $100k? That is my point...
The easiest way to think about those questions is to construct a market value balance sheet in your mind:
See a simple example
Assets: Unlevered Value Of the Operating Business (assumes full equity financing) Debt Tax Shields (here we factor in the capital structure) Excess Cash Investments in Associates Liabilities: Market Value of Debt Market Value of Equity Market Value of the Minority Interest
Case by case you include different assets and liabilities (e.g. pensions, preferred shares...). The general rule is that it always balances. So the company found cash: Excess Cash increases and then its balanced out by the increase in equity value, therefore the EV is still same.
Similar questions are: What happens to EV if the company issues debt or shares? EV is still the same.
With this way of thinking one can answer not only those questions, one can also unlever/delever betas, find the connection between APV and DCF and understand implicit cost of equity assumptions
Enterprise value isn't the market value of a firm's assets. That's TIC/MVIC. Everyone confuses this shit. EV is the market value of a firm's operations. They're different.
Where did I say that asset side is the enterprise value? You can easily get to the enterprise value within my framework...
In simple terms, enterprise value is the value of operating a business; i.e. operating assets - operating liabilities. If cash goes up by $100k, does that change either op assets or op liabs? No, it wouldn't. To be more specific on the BS, cash would increase on assets side, and the cash is now "available" to equity holders (you can also think of the company's net worth increasing), and so equity value goes up by same amount.
You could check out what Einhorn (or Icahn) said about Apple's cash a few years ago if you are interested in how investors value cash sitting on a company's balance sheet...
https://www.scribd.com/document/126634859/David-Einhorn-s-Apple-Inc-iPr…
Can't view the link, but you don't have to be David Einhorn to understand why too much cash on a balance sheet is bad for investors. Either put my money to work or give it back so I can do something useful with it.
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