Hi, this is an interview question im struggling with:
lets say an a company has a $100 EV.
What is the impact on this EV of a $100 bond issuance?
I was told it stays at 100 because of cash netting, can someone explain this?
Thank you!
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In the simplest scenario:
If you sell a $100 bond then you receive $100 in cash from investors for the bond, increasing debt by $100. If you dont spend that cash then it is added to the cash account, increasing cash by $100. Since you need to add debt and subtract cash to get EV the two offset each other.
To go a step further, the effect will only be zero if you expect the return on the capital (the debt) to equal the cost of the debt (cash sitting there earning 2% when debt costs 8% will erode value). If you love the company's mgmt, you would expect them to invest the new capital in value accretive projects (ie return > cost of debt capital) and therefore EV increase to account for the PV of the new cash flows above the cost of funding capital.
Thank you both so much!!
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