Hey,
I have an interview and I really can't understand why we add debt to equity value on the enterprise value. Doesn't the equity value already automatically discount the debt and thus only the real amount to be paid is left? I read that the buyer always was to pay for the debt but I just can't understand why...
Does anyone has an example where its more clear?
Thanks
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Hey I'll give it a go.
Enterprise value is what you'd pay in the market for the company as is. Meaning you'll take on it's debt as well.
Equity is only the portion available to share holders.
So it's basically as if I brought forward all the debt payments I would need to pay in the future if I only bought the equity today?
You buy a house for $100k with 20% down and an 80% mortgage from the bank. Your equity value is $20k, the debt financing from bank is $80k. The house is still worth $100k. If I want to buy that house from you, I can't just write you a check for $20k. I need to pay the $100k that the house is worth of which $80k is debt.
When you are buying a business (or anything for that matter), you don't simply pay the equity portion. When you are selling something, you only receive the equity value.
ok I get your example. I think I was making the mistake of thinking of equity value as already net equity (assets - debt). So when we talk about equity we are just talking about assets by themselves and not net assets?
I also don't understand something. There are two competitors, with exactly the same businesses and market cap, lets say 100M. One has 0 debt the other has 50M in debt.
According to EV it's more expensive to buy the one with 50M in debt, for a total of 150M. So why would anyone buy this one if they can buy the exact same business and pay just 100M?
If you have company A = 100m market cap + 0m net debt = 100m EV
and company B = 100m market cap + 50m net debt = 150m EV
Then company B has a higher EV, but it is only "more expensive" when comparing the EVs to their respective EBITDAs (or EBITs, or revenues)
If both companies generate 10m of EBITDA, then company B is more expensive (15x EV/EBITDA vs 10x EV/EBITDA for company A)
However, in this scenario we are assuming that the 50m of debt financing has had minimal impact on EBITDA growth for Company B - this is unlikely.
Even if both companies did generate the same EBITDA (so 10m), then why is company B more valuable than company A? (15x vs. 10x) - could be down to a bunch of other factors (historical and projected growth rates, market leadership, proprietary technology, etc.)
Well, it seems that there ir no real reason why I should pay for company B instead of A right? With less 50M I can buy A and get the same EBITDA no?
So does this mean this situation means company B just spend the debt unwisely and now its at a "disadvantage" to company A?
Think of the basic accounting question - when you buy a publically traded company, you're buying all of their assets listed on their balance sheet - which for this example, we'll pretend BV = FMV.
How did you pay for those assets? Well they were either financed internally / organically, by way of net income and retained earnings (RE) , or they were financed externally with debt (L) or with equity raised in an IPO/shelf offering (CS+APIC).
A = L + RE + CS + APIC
A = L + E
Why do we subtract cash?
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