Why does enterprise value not change?
Q: You have a company with 10 shares @ $20/share, 600 debt, 250 cash, 50 working capital (only subtract excess cash), and 50 non-controlling interest.
A: The company uses $100 in cash (from issuance) to acquire another company. What happens to EV? There will be a $100 increase in asset value and a $100 decrease in cash as we use the cash to purchase the company. Consequently, there is no net change in EV.
Why is this the case? I thought that the cash would decrease by $100. I understand how the working capital could increase by $100 and make the enterprise value ultimately the same, but is that not double counting?
You have some cash in your pocket. You spend that to buy something that’s worth the exact same as cash you have. What impact does it have on your net worth?
Oh yes, that makes more sense. I can't believe I didn't think of it like that. Thank you!
Different analogy. Net Worth is equivalent to Equity Value / Net Assets (because Cash is included).
Coming back to OP's question, Equity Value will not change (same concept as above). In addition, when you do a consolidation of balance sheets, you only retain the parent company's Equity and eliminate the subsidiary's Equity. Therefore, from Accounting standpoint, Equity Value also doesn't change.
However, Net Debt increases because Cash decreases. Therefore, Enterprise Value increases.
Another way to look at this is that through this acquisition, Net Operating Assets increases (acquisition of PP&E, investory etc.). Therefore, Enterprise Value increases.
So, you are saying the enterprise value does increase? The answer I have says that it doesn't increase, but I am not sure if that is correct if I'm being honest. I originally thought that because you have a reduction in cash when you purchase the asset the enterprise value would increase by $100. However, I also see the point that the Enterprise Value represents the "true cost" of acquiring a company. So, shouldn't the true cost still be the same?
Don't understand your question. Accounting 101:
- You credit (-) $100 from the cash journal because you use this amount for the purchase.
- You debit (+) on any asset journals whatever you buy from that company and the rest, the difference, is debited (+) to goodwill, totaling $100 (that's what you paid to buy it).
Your asset side remains the same size, so EV is the same.
Coming from a BIWS guide: "because these Acquired Assets are operational (the split between Existing Assets and Goodwill/Intangibles is irrelevant), and no
Operating Liabilities change. NOA is up by $100, so TEV is up by $100". The underlying principle here is that enterprise value comes from the firm's net operational assets. You're taking the cash, a non-operating asset, generated from the issuance (doesn't actually matter that it's from the issuance, since capital structure changes aren't materially impactful on TEV) and putting it into an operating asset.
Take this with a grain of salt, I'm a prospect and just parroting what I read in the guide.
Exactly my understanding as well.
Changes in NOA lead to changes in EV. Changes in capital structure do not (only on a high level. Changes in discount rate, risk of bankruptcy etc. will lead to actual changes here)
Also good to see this from an EBITDA x Multiple view: assuming you buy the target for the same multiple you are trading at, EBITDA increases, Multiple remains unchanged -> EV increases. Reduction in cash offsets the effect, thus leading to no changes in equity value
I don't understand the Q or a few of the responses here. So far as I can tell, Enterprise Value does change.
Let's strip things back a bit. I waddle over to you with literally nothing. I have no enterprise. I propose to sell you 100 shares for $1 to fund my idea. So now I have $100 cash and $100 equity (or debt, if you loaned me the money). But no Enterprise Value - there's no "enterprise" (operating assets), just a pile of cash.
Now if I use that $100 to buy a company (or machinery, it doesn't matter), things change. Now I have a business, or enterprise (operating assets). And $100 of equity. Enterprise value changed.
The explanation I can think of for the answer is that the "change" is the total EV of BOTH companies versus the EV of the pro forma company.
Cash in not an operating asset so it doesn't affect EV. Assuming you're acquiring operating assets in the acquisition, operating assets are up $100 and cash decreases $100, but they're not an operating asset so they're not affecting EV.
EV increases by $100 on acquisition
no change when issuing shares because the equity value and cash cancel out in the bridge
The EV does change. EV isn't net worth as someone else suggested. Think of it as the size of the operation.
Think of a house. If you have a $1 million house, the EV is $1 million. The equity value can vary depending on how much mortgage is on the house. But EV is $1 million regardless.
Now let's say you put $500k of cash in a box inside the house and sell it like that. The house would now sell for $1.5 million, but the EV is still $1 million.
But if you took the $500k cash and used it to make improvements that are worth $500k, you now have a $1.5m house and $1.5m EV.
Perhaps the most tangible answer here.
It also highlights the case that "the company" (per OP question), may just be a shell company with 100 in cash... Leads to different answers on EV and Equity.
Nice house btw.
Most responses here seem like blind leading blind.
EV increases because you are converting non op asset (cash) to op assets (other firm’s).
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