P/E Ratio & DCF
- How does the P/E ratio change if cash goes up?
- How does Enterprise Value change in a DCF if depreciation goes up?
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It should not have any direct impact, assuming the Cash has no PnL effect and just SCF effect. Indirect: If the cash is excess cash, then it depends how the dividend policy of the company is. If all excess cash is paid out, then it has also no effect on the P/E ratio. If there is a payout policy and company does not pay out the excess cash, it can be a negative signal and price could drop. (But this is just my opinion, could also have positive signal maybe, depends on the situation) Another case: company has an optimal cash management --> no effect on P/E since we do not have excess cash.
Let´s begin here with the FCFF. Since dep. is added back here, it will increase our FCFF. (No assumption about where the dep. comes from/ so our CAPEX stays same) So, since our FCFF increases and our WACC stays same, we will have a higher EV.
Then you ask how is earnings per share calculated? EPS=total earnings/outstanding shares
Next, you ask how is total earnings calculated? Total Earnings=net income-preferred dividends
Next, you ask how is net income calculated? Net income=total revenue-total expense
I assume "cash going up" is total revenue going up. Based on the formulas presented, it will mean net income will increase which means total earnings and EPS will also increase, leading the P/E ratio to decrease.
First, you ask how is the enterprise value calculated. Enterprise value is calculated by taking the present value of cash flows, divide each by the discount rate and add the results.
Then, we ask how to calculate free cash flows.
Based on the above formula enterprise value will also go up.
Take my answer with a grain of salt. I am just a guy who has access to Google and tries to break the quantitative questions down to individual formulas.
first question I think not clear as you don't specify if cash increases through debt raising, but all in all effect will be on net income though impact on interest expenses
Meant to give you a banana.
Also the fact that you add D&A back when calculating FCF.
With regards to tax, you get tax savings from the D&A. I'll illustrate with an example:
Lets say we have £300 EBITDA, £20 depreciation and a 35% tax rate
£300(1-t) = £195 £280 (EBIT)(1-t)+D&A = £202
What does PS stand for dude
Depends on how you view this, it's a question that's more theoretical than practical...
Argument can be made: 1. Cash goes up 2. Interest income (say $1 after-tax income) 3. Net income is now up $1 4. Say 10% discount rate
$1/(10%) = $100 to your equity value.
Though keep in mind everyone's answer makes a valid point. Theoretically, it would either come from Revenue which turns more mechanics than my simple example, or it comes from Debt/Equity.
Question 2 has been pretty much covered, but I think question 1 hasn't been answered correctly yet. Assuming this is for an entry IB analyst/summer analyst position, this is probably supposed to test concepts of enterprise value and equity value.
If cash goes up (looking at it in a vacuum, so assuming no other changes), enterprise value isn't affected since enterprise value measures the value of the firm's operating assets (and cash is a non-operating asset). Since EV=Equity Value + Net Debt, and now net debt is lower, equity value increases. If equity value is higher, the "P" in P/E is increased, so the P/E ratio increases.
How does price or in other words market value per share relate to EV?
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