Simple EV question

Tabur1's picture
Rank: Senior Chimp | 26

Hi,

I'm stuck with a problem that's ridiculously simple, but I can't seem to wrap my hear around it...

Let's assume there's a company that will invest 450 bucks of CapEx next year to get a stream of free cash flows. When discounting both the CapEx investment (negative number) and the FCFFs at a certain WACC (let's say 8%), the value is 180 bucks. There's no cash nor debt lying around, the company is basically a 0-risk project, and therefore, 180 = EV.

Rationally, I wouldn't pay more than 180 dollars between Debt and Equity (at the proportion used to calculate the WACC) to buy this company, but the company has to invest 450 bucks and someone has to fund that. If I raise 300 debt, and 150 equity to fund operations, but EV is 180, wouldn't that make my equity -120?

The logic I use is this: The acquired company is worth 180, and it has 300 in debt. EV = Eq - Net Debt, therefore, Eq = -90.

Where is the mistake?

Comments (23)

Feb 11, 2017

seems like you're mixing concepts here.
for your example, if you raise 450 in financing, your EV is 450. investing in positive NPV projects shouldn't decrease your EV.
also equity value can't be negative.

hope that helps

hmm

Feb 11, 2017

I'm confused... Independently of the financing I raise, if I have a stream of FCFFs my EV shouldn't change. If raise 450 in debt, or 450 in equity, the EV should always be 180 no? (since it's the NPV @ WACC of the FCFFs).

My question is more like, if I don't have debt now, but I know I'll raise debt in the future, how does that affect the equity value having a fixed EV?

Thanks for the reply!

Feb 11, 2017

in simple terms - your EV is market value of debt and equity. the npv of your investment goes on top of whatever financing you already have in the firm.

to answer your second question - in a theoretical scenario without taxes issuing additional debt won't affect EV (since issuing new debt equally affects both sides of balance sheet)

hmm

Feb 11, 2017

Yeah, you're way off base here.

EV is not about NPV. NPV is for go/no-go decisions and return calcs. The book value of your business is $450. The market value is somewhere around $630 (assuming the $450 expense occurred in period T0). Sum of the present value of your cash flows. That's your EV.

Feb 11, 2017

That's what I meant by NPV of FCFs. So basically I'll have a big CapEx first year and then a bunch of positive FCFFs (no terminal value). When I discount that stream of FCFFs at the WACC, I get 180.

Having said that, if the company has no debt now, and I know it will have to raise 450 debt in two years, how would I calculate the equity value?

Feb 11, 2017

for the theoretical example here, you can just use book vale of equity

hmm

Feb 11, 2017
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