technical: equity cushion calculation
Hi fellow monkeys
having some difficulty understanding the equity cushion calculation, normally, people calculate it as:
[1 - (debt/ebitda / ev/ebitda)] = equity cushion, this equation can be simplified to [1 - (debt/EV)]
however, my problem is that EV subtracts cash out of the equation.
Imagine two scenarios, CompanyA and CompanyB
CompanyA has a Mkt cap of 100, and Cash of 100, and Debt of 500
CompanyB has a Mkt cap of 100, and Cash of 0, and Debt of 500
CompanyA's EV is 500, and equity cushion is 0
CompanyB's EV is 600, and equity cushion is 16.67%
Okay so CompanyB has a higher equity cushion, but is this really the case?
Lets take a look, first, we note that CompanyB's value completely lies in the business, the business is worth 600, and therefore, if the value of the business is impaired by 16.67%, the business is worth 500, just the amount to cover the debt. Goods good here.
But, if we look at CompanyA, we note that the value of CompanyA lies in the business and cash. The business of CompanyA itself is worth 500, hence EV of 500, but there is 100 of cash balance as well. So what does this mean, TO ME, it means CompanyA's business can lose 100 in value, and still cover the debt - this is contrary to the equity cushion calculated. When CompanyA's business loses 100 in value, the business is worth 400, true this would mean the debt is impaired, BUT remember we have 100 cash as well, adding it together means there is 500 in value in total at CompanyA, just enough to cover the debt. So despite the 0 equity cushion calculation, there is ACTUALLY a cushion of 100, the equity cushion of CompanyA and CompanyB is the same. (Correct?)
Can someone please tell me if I am doing something wrong here?
bump
Just use Net Debt instead of Debt...I've never heard of the "Equity Cushion Calculation" but that seems like the logical thing to do...
.
Better to look at an equity cushion in terms of turns of leverage
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