WC changes impacting EV

Having a bit of trouble understanding how changes in working capital impact enterprise value.

I'm reading that an increase in net operating assets would result in increased enterprise value, but not sure how that works based on the enterprise value formula.

If inventories increase, cash falls and inventories rise on the balance sheet. Does enterprise value rise because cash falls, since it's subtracted?

 
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As EV represents the value of the net operating assets in the business, I think the most intuitive way to think about EV questions is whether it impacts NOA.

Inventory is an operating asset - as inventories increase, NOAs increase - increasing EV
 

This is irrespective of funding as EV does not change for financing events (only changes to the core business). 
 

  • Cash funded - cash decreases by $100 - EV increases by $100. 
  • Debt funded - debt increases by 100, cash increases by $100 (and then immediately spent on inventories, decreasing by $100 so net change is $0) - EV increases by $100. 
  • Equity funded - common equity increases by $100, cash increases by $100 (and then immediately spent on inventories, decreasing by $100 so net change is $0) - EV increases by $100. 
 

incorrect. you're conflating two different views of EV.

if cash decreases by $100 then you're using EV = sum of cash flows and you need to figure out how that $100 cash outlay into inventory factors into some future increase in FCF to get net effect on EV.

If debt goes up by $100, then you need to document it as two changes. First debt increases and cash increases (no effect on EV). then you do the same thing as above with cash.

Same thing with equity: equity goes up and then cash goes up (no effect on EV). then do the same thing as above with cash.

 

Respectfully, I don’t believe it’s incorrect, just a different line of thinking. 

Your are analysing the value of the assets acquired on an NPV basis which I understand completely. That is, what is the NPV of the value we can extract from acquiring these assets? 


The way I laid it out is much more ‘theoretical’ in that it implicitly assumes that inventories are acquired at fair value and as such the NOA of the company rises, increasing EV. This does not account for the additional value to the firm you may receive in the future from the use of those inventories in this method (which differs from your NPV method). 
 

As you and I have both outlined, how the asset is funded is irrelevant. 

 

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