Change in equity value as result of paying down debt
Hi everyone,
I am confused to how equity value increases as result of paying down debt with the LBO target's cash flow after the acquisition.
According to Investment Banking by Rosenbaum&Pearl and other online sources that describe this process, since equity value = enterprise value - net debt, because enterprise value does not change from paying down debt, decreases in net debt increases equity value. This also makes sense when I am thinking about it from the perspective of "equity value = all asset value that is available to equity shareholders", as less debt increases the value for them.
However, in the most basic equity value/enterprise value concept questions, when a company uses $100 in cash to pay $100 in debt, equity value does not change as (accoridng to the M&I guide) "a common stock issuance was not responsible for this change. It involved Cash and Debt, not stock".
Hence, I was wondering if someone could explain the difference between these 2 scenarios, and why in the LBO scenario equity value would increase, while in the second scenario it would be unchanged. Thanks!
Not sure wether this is entirely correct but ill give it a shot:
I believe its about perspective.
In the first LBO scenario, you are describing the process of generating cash over a period of multiple years, which is then used to pay off debt after each year. The equity value will rise from using this newly generated cash in future periods and the subsequent repayment of debt with this "new" cash, not the cash we already currently have at hand.
Your second scenario assumes repaying debt with cash at hand from a prior stock issuance (which is not considered right now). As ND in its simplified form is generally calculated as Debt - Cash (unrestricted), if we use existing cash to repay debt, it will make no difference as both figures go down by the same amount.
Any corrections to this are welcome
Thanks! I think that makes a lot of sense.
Equity Value when Repaying Debt (Originally Posted: 09/24/2017)
Hello, quick question regarding a particular interview question:
What happens to the equity value when you repay debt?
The answer says that equity value stays the same when you repay debt. If I'm not mistaken, equity value is defined as value of all assets related to the EQUITY SHAREHOLDERS ONLY. Therefore, when you are paying down debt, cash goes down, so shouldn't equity value go down? For a similar example, equity value goes down when you issue a dividend because cash (asset) goes down.
Help is greatly appreciated
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