IBD Interview Question: Can Enterprise Value be negative?
I was asked by the interviewer if the enterprise value can be negative. I answered that if cash is larger than the sum of debt and market capitalization, enterprise value will be negative. However, the interviewer said that cash is already included in equity.... Not sure what he really wanted to say (would like to know more about it)... Is there any other possible scenario that could give rise to a negative enterprise value? Thx a ton!
Cash is implicitly accounted for in equity value which is why you subtract it in the enterprise formula to isolate the actual value of the business' operations.
Negative enterprise value is common for financial institutions such as banks which have a large cash balance from deposits (which is used to generate returns). However, this is exactly why you wouldn't use enterprise value to value a bank and would instead use equity value.
I could also envision a scenario where a Company's equity value is less than its current cash balance if they are on the brink of losing a large lawsuit and thus would be expected to payout a large sum of their cash balance as a settlement. This could give rise to a scenario where equity value cash, and assuming no debt, would create a negative enterprise value.
thank you, that is very helpful!!
A quick question: I know that cash is implicitly accounted for equity value given that enterprise value= equity+ debt-cash. When you rearrange the equation, you will get Equity=enterprise value-debt+ cash, but what is the underlying logic that equity value includes cash? I have heard people saying that cash sitting on balance could be used to pay out as dividend, pay down the debt, or invest in a project, which all will give return to equity holders, and that is why equity includes cash. However, I am having a hard time to see the link between the uses of cash and the fact that equity value includes cash. Would be really appreciated to hear your answer, thx a ton!!
Cash is something owned by the company. Let's say the company gets a 100mln windfall, its equity value will raise because now they own more assets and equity value represents the value of the entire company for the equity holders but the enterprise value would be unchanged because that accounts only for the value of the core business.
thank you very much, thats very helpful!
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