[associate interview technical] Negative implied equity value as a result of debt?
How would you all answer this technical?
Interviewer: How do you calculate equity value from Enterprise Value?
Interviewee: You would take the Enterprise value, add cash/cash like instruments, and subtract debt/debt like securities
Interviewer: OK. Now imagine you have a company with an enterprise value of $200MM, Cash of $50MM, and Debt of $400MM. What is the equity value of the company?
Equity value can't be negative. Although it's mathematically zero I'm assuming the answer lies somewhat in the debt. Would it be the case that this is a distressed company and the market value of the debt would actually be less than $400mm, so the equity value would be close to zero? Or that the equity value is zero because equity owners wouldn't get any value in the company?
Wouldn't this sort of be a trick questions and you say you don't know?
equity value can never be negative and he never mentioned the other components
Not sure myself would love an answer
This is how I would go about it: If we're talking market value, then it's impossible (share price can't be negative) However if we're talking book value, then equity value is composed of retained earnings which can be negative.
This is the correct answer. Book vs market value of equity can often be confused with each other, and they are not the same.
I'd agree with the above, but it also depends on the industry you're interviewing for. If this came up in an RX interview, I'd definitely talk about the latter being a distressed company.
Odds are the face value of debt is $400MM, but the market value should in fact be 37.5% of face value. This is implies a distressed company and since you cannot have a negative market value of equity, you have an equity shortfall where you treat equity as inherently zero and in the stock market I'd expect the stock to be trading on its option value.
How did you get 37.5%?
Edit: Do you mean 62.5% of face value because considering the company's cash position that would imply an equity value of 0?
Oops yeah, sorry bad at math over here apparently.
"Would it be the case that this is a distressed company and the market value of the debt would actually be less than $400mm, so the equity value would be close to zero?"
I think you got it. You can compute TEV using both book value and market value of debt.
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