Comments (22)

Oct 10, 2011

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Feb 3, 2011

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Feb 3, 2011

think about it like this, two companies otherwise equal except one has a shitload of cash and the other has nothing. which one has a higher market value of equity? and you don't add excess cash to get to enterprise value. only on wso...

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Feb 3, 2011

Left Handed Monkey, in Patrick's technical guide, it says "cash is already accounted for within the market value of equity."

Feb 3, 2011

some of these responses are completely off, i wonder where the hell u guys are getting these junks from...

to the OP:
if you're valuing a company's equity using the DCF method
cash flow is basically the most important variable in determining the value of a company

A company's total enterprise value/worth is made up of Equity/Debt
more like every dollar on the asset side of the BS is financed with either debt or equity
so to value a firm's equity you first find how much the entire enterprise is worth and subtract the outstanding debt from it to get the equity value

Lets put aside the argument of whether DCF accurately captures a firm's value for a second and just go over the theory. Much like valuation of bonds, DCF derives the value of a company based on expected future cash flow.
Sum it up, you project the amount of free cash flow available to both creditor/shareholders into the future, discount it by the proper WACC/rate and you'll get yourself an enterprise value.

Obviously the model/theory is only as good as the assumptions, thats the tricky part of DCF, you're are basically projecting into the future, hence many ppl on the street discredits it

I hope I've helped with your question OP

    • 1
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Feb 3, 2011
J15:

some of these responses are completely off, i wonder where the hell u guys are getting these junks from...

to the OP:
if you're valuing a company's equity using the DCF method
cash flow is basically the most important variable in determining the value of a company

A company's total enterprise value/worth is made up of Equity/Debt
more like every dollar on the asset side of the BS is financed with either debt or equity
so to value a firm's equity you first find how much the entire enterprise is worth and subtract the outstanding debt from it to get the equity value

Lets put aside the argument of whether DCF accurately captures a firm's value for a second and just go over the theory. Much like valuation of bonds, DCF derives the value of a company based on expected future cash flow.
Sum it up, you project the amount of free cash flow available to both creditor/shareholders into the future, discount it by the proper WACC/rate and you'll get yourself an enterprise value.

Obviously the model/theory is only as good as the assumptions, thats the tricky part of DCF, you're are basically projecting into the future, hence many ppl on the street discredits it

I hope I've helped with your question OP

thanks for telling us what a dcf is. for most of us, this is a new concept.

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Feb 3, 2011

I'm actually referring to a question in the M&I guide: Why do you subtract cash from EV. His answer was that cash Equity Value implicitly accounts for it. How?

Jul 20, 2018

I've always thought of it like paying for cash with cash. If a company's value is determined to $1mm, and the cash balance is $100k, I'm not going to pay $100k to get $100k. That's like taking a dollar out of my left pocket and putting it into my right pocket. Instead, the $100k cash balance is subtracted to get to EV, and the assumption is that the cash balance will be used to retire debt or shore up the cap structure in some way.

Feb 3, 2011

Cash is subtracted because it can be used to pay off some of the debt or to pay dividends. Also, it is already accounted for in the market value of the equity.

Feb 3, 2011

Also, it is already accounted for in the market value of the equity.

Yeah that was my question...why/how is it accounted for the in market value of equity?

Feb 3, 2011

when the cash is used to pay down debt, the equity portion of the EV increases and the debt portion of EV decreases. the assumption is that cash on hand is limited because the return is very low. Either it is paid out in dividends, reinvested in another project, or used to pay down debt -- all activities that flow to equity holders.

Sep 4, 2016

Thanks for the explanation, but I'm a little bit confused. The equity portion of the EV is the Market cap, not the shareholders' equity on BS. I was confused why the equity portion of the EV increases when the cash is used to pay down debt? Market cap is price times shares outstanding.. so do you mean there happens something to share price or share count when the debt is paid out w/ cash?

Array
Feb 3, 2011

Enterprise value-Debt (must pay off debt before equity has a claim)+cash (because current cash on hand is not factored into the DCF calc) =Equity value

Feb 15, 2011

i'd like to hear the definitive answer to this as well. my thinking is that if i'm holding stock in a company sitting on a ton of cash, i'm assuming that the company will either a) invest cash into products that generate returns above the hurdle rate or b) redistribute the cash back to equity holders in dividends or stock repurchases.

Because I'm seeing a return either way on that cash hoard, it affects my purchase and pricing decision, and therefore is captured in the equity value.

Feb 15, 2011

easiest way I think about it is the balance sheet equation:
A- L = Stockholders Equity

Thus equity implicity values the cash on the bs

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Feb 3, 2011

For Valuation purposes: Equity value= EV - Debt (since equity holders have no claim on this and is included in EV calc) + cash... This is used usually in a private company where you use a DCF to calculate EV and want to figure out the value of the common shares

But if you are solving for Enterprise value; Stock price * shares outstanding=equity value; Equity Value + Debt - cash= enterprise value...This is why you use EV/EBITDA multiple or P/E; the former are both before consideration of debt and the latter after...

Final answer.

Feb 15, 2011

Think about this intuitively, would you rather pay more for a company with $50 billion in cash or $50 million in cash - ALL ELSE EQUAL?

Jul 11, 2012

Subtracting cash makes no sense. Upon purchase, a buyer gets the excess cash sitting on the BS of the target, so the buyer needs to pay for that cash right? Say there's $100 of cash on the BS - if that $100 is not included in the price (i.e. the enterprise value) paid for the target, then the buyer is getting $100 in cash for free, right?

In other words, that cash has a value ($100) so why is something of value not included in the purchase price? The $100 is implicitly included in equity value and should REMAIN included in the equity value rather than being subtracted and netted out - otherwise, as I explained, it's a free $100 for the buyer, right?

    • 1
Jul 20, 2018

Because that cash doesn't belong to you upon purchase it belongs to the shareholders.

Best Response
Oct 21, 2013

Hey guys,

This is the height of us confusing the unnecessary. It would be amateur of us to simply follow a rule to deduct cash from EV and forget about how the EV is derived.

As already pointed out by other friends, Equity = Assets - Liability. It can also be pointed out by using: Equity = Assets - Net liability (debt net off excess cash). Hence Equity value has in itself the cash component which is a current asset.

How to derive Equity Value same from EV? When deriving EV from Discounted Cash Flow (DCF), we tend to forget what D/E ratio we had used. Few people use net debt (net off excess cash) for D/E while others use total debt in (D/E) ratio. The latter is greater than the former because excess cash increases both sides of the equation D + E = Assets. Moreover, it is appropriate to use total debt because of the tax advantage for the debt.

When WACC is calculated using D/E (total debt/equity), the resulting EV will have the excess cash component.

For actual EV in the above case, the excess cash is deducted to keep both sides of the equation at optimum level. L + E = Assets. When excess cash is not deducted, the Liability shows high against high cash balance on the asset side.

When deriving Equity value from Enterprise value we can use two methods:
EV - Net debt = Equity value
EV - Total Debt + Excess cash = Equity Value

Both will be the same. But what would be wrong? EV - Net debt - Excess Cash = Equity Value (Never !!!)

If we see where we started, we know where to end and what to add or subtract. Nothing biggie ;)

Thanks,
Ari

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Sep 4, 2016
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Jul 20, 2018