Question: A company uses $100 of cash to buy US Treasuries. Walk me through the impact to Enterprise Value and Equity Value.
Answer: “Enterprise Value is unchanged. Equity Value is unchanged.”
Struggling a little bit with this one. If equity value is unchanged, but cash has decreased, shouldn't EV increase? Would anyone be able to walk me through this one? Apologies if it's a simple question...
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Treasuries are generally considered cash equivalents and included in "cash" in your valuation since they are non operating assets that are highly liquid and can be easily converted into cash. Few companies actually keep large amounts of cash in a bank account earning little to no interest. In fact, when you include the "face value" of cash in a valuation you are inherently assuming that the cash is invested and earning at a minimum the risk free rate.
Super helpful, thanks a ton for the detailed response!
"Associate 2 - PE LBO"??? EV unchanged because you exclude cash & equivalents, and here you make the argument that US treasuries = cash & cash equivalents. Eq.V = EV - Debt, so again, no impact.
Or, to make it simpler, why would someone pay extra for something that he could replicate for himself on his brokerage account?
Or if you really want to complicate it and stretch the argument, you may say that EV changes based on the accrued interest on the treasury. Face Value of US treasury - price paid = your return, but you can't get this return yet, what you have is something abstract called accrued interest, which it will materialize once the treasury reaches maturity. This should increase your market capitalization in the EV formula because excluding cash & cash equivalents is an accounting thing, but the accrued interest is a finance concept left out from this equation and not reflected in cash & cash eq. In the same proportion will grow Equity Value because you're just removing debt. If you need some bond theory to understand it, I can elaborate more.
Thanks for the reply. I think the second part mostly makes sense but wouldn't say no to more elaboration... and thanks for reinforcing my acute imposter syndrome, lol.
Edited for clarity:
Just check the formula on how to calculate the accrued interest on bonds. All bonds traded on secondary markets, including US Treasuries, won’t quote this accrued interest, but you are always expected to pay it. So, when a company, for example, has $100 in cash and cash equivalents, with $20 held in US Treasuries maturing in 4 weeks, your accountant will say that you can’t recognize any interest because you haven’t received it yet. Since you can’t reflect it in the financial statements until you receive it, the EV/EqV calculation takes this purely from an accounting perspective, ignoring an element that increases market capitalization: the entitlement to receive some interest on an instrument, which lacks a contractual nature to be recognized by accountants because it's an implied interest recognized by financiers.
To elaborate further, if you are valuing the company two weeks after it bought the US Treasury, that Treasury, which was purchased for $998 and will pay $1000 in four weeks, may have accrued $1 in interest. This means the real value, based on the market, is $999 instead of $998. This value is not a "market value" in the traditional valuation sense, where you research and determine that an asset could sell for $200 because its market range is $190–$230. Instead, accrued interest in the bond market is fairly fixed, and you can’t ignore it.
It essentially reflects the time value of money, something the seller of a US Treasury would expect to receive if you were to buy the Treasury from them. Remember Finance 101: if I buy something for $998 and then, after two weeks, sell it to you for the same $998, you’re effectively doubling your return. I am waiting four weeks to receive a $2 gain ($1000 - $998 = $2), whereas you would receive those $2 in just two weeks. Accrued interest harmonizes the time value of money in bonds, though it remains unseen and unrecognized in accounting terms.
Theoretically, it shouldn’t be ignored, but in practice, it is disregarded in EV/EqV calculations because its impact on a company’s value is minimal. However, once you receive the face value—say, $1000—you simply exclude it from EV, leaving EV unchanged. That’s why calculating accrued interest doesn’t make sense: at the end of the day, it doesn’t impact EV, and we care about cash, not some abstract finance concept.
Ultimately, this is an extreme stretch and an unnecessary calculation unless the company holds, for instance, 80% of its assets in US Treasuries or another significant percentage that makes it worth considering. If you were asked this, it was likely just a mental exercise to assess your judgment.
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