Adjust Enterprise Value for Pensions and Provisions
Hey guys
I have a rather basic question about Enterprise Value calculations.
I know EV calculations (EV = MarketCap - net debt) by heart and I have doen adjsutments for preffered stocks and minorities. However, during my internship I always had to adjust for pensions and provisions as well (add). I am not quite sure if I know the sole reason why I did it but I think it is the same reason why I adjust for minority interest and preffered stock.
What I really want to know is if this method (the adjustment for provisions and pensions) is a common procedure or if it is bank specific. Furthermore, I would like to know why one adjusts for "net pensions", namely (benefit obligations - funded pensions) [post tax].
thanks
Adjusted Enterprise Value
The need for adjustment comes from where the liability falls. For defined contribution pensions any risks associated with the invested assets falls on the employee. In a defined benefit pension the company assumes the assumes the risk. This is because the company has promised to pay a set amount to the pension holder. This obligation of payment is what creates the liability for the company.
For enterprise value, defined contribution (DC) pension schemes are not relevant as the employer pays a fixed amount into a pension fund. The investment policy of the pension fund determines the (variable) pension for the employees. As the company has not offered a pension promise to its employees it neither recognizes pension liabilities nor pension assets on its balance sheet.
Defined benefit (DB) schemes matter for Enterprise Value as the company commits to pay a fixed amount to the employee on retirement. This puts the risk with the employer to pay the pension and hence creates an economic and accounting liability.
To measure the pension liability, companies forecast the future pension payments by taking into account employee variables such as inflation, mortality and retirement dates. These future pension payments are then discounted to the present to get a pension liability. In addition to providing pension benefits to their employees, companies, particularly with activities in the US, offer post-retirement health benefits that also have a defined benefit character. This means the total obligation to employee benefits combines defined benefit pension plans and other post-employment benefits.
For Enterprise Value, view defined benefit obligations as a loan provided by employees to the company to be repaid upon retirement. Typically in the annual reports, Fair Market Value of Pension Assets and Pension Liabilities is mentioned.
For a more general overview of enterprise value, check out the video below.
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My bank had the same:
Adjusted EV = Market Cap + Interest bearing debt + preferred + pension deficit (you don't subtract pension surplus) + minority interest - cash and cash equivalents +/- depending on which industry (ex. site clean-up costs if you are looking at Power & Utilities or if you are looking at an auto industry, you would subtract financial services debt and equity related to the financial services division and etc.)
Am I missing any?
You would want to adjust for pension deficits because these are something that you HAVE to payout. Other adjustments such as the site clean-up costs for Power & Utilities companies are there because these companies are obligated to clean up their sites by law. and etc. etc...
I think you can add provisions (reorganization, rationalization, reconstructuring) as well, which i think "´site clean up" expenditures fall under
Why?
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