Enterprise Value

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pepp

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Can someone explain me the rationale behind EV formula.
EV = market value of common equity + market value of debt - cash
If a company has $100 of cash, and $50 of debt, isn’t the company worth $50? I won’t pay more than $50 to buy this company.
but according to the formula above you’d get -$50.
Someone please help.
 
I can’t understand why a company’s debt would be added to its value.
In my opinion a company’s debt should be should be subtracted from company’s total worth.
 
Don’t forget investments!
EV/EBITDA is a common formula
EV = MV debt + MV equity - cash - INVESTMENTS
The will try to catch you out on this.
 
technically EV = MV debt + MV equity + preferred equity + minority interest - cash and cash equivalents
pepp, the reason why you are confused is that you are looking at from the stance of the equity holder. EV is a measure of ALL holders of capital in the firm, less any liquid NON-operating assets. It’s a measure of the firms OVERALL operating value.
debt holders, equity holders (common and preferred) and minority interest all have claims on the firm’s mass of operating assets. This is what EV measures.
Consequently, EV is often compared with EBITDA, a pre-interest, pre-tax rough estimate of CF (as D&A is often the largest NCC.) EBITDA thus is a rough estimate of CFs available for ALL holders of capital in the company. Since they are comparable by this measure, EV/EBITDA is a valuation estimate.
 
Look at your first formula:
Equity + Debt - Cash
So for a company with $100 cash & $50 Debt…
$50(assets-debt=equity) + $50 - $100 = 0.
Still doesn’t make sense, but at least it’s not negative!
 
Also, I would like to add the following.
EV in this formula (debt + equity - cash) is an acquirer’s perspective too.
An acquirer is buying out all holders of claims - both the equity and debt holders, but the acquirer will also get access to the target’s cash when the acquisition is completed. This cash can be used by the acquirer. So, it is like an immediate return.
So, from an acquirer’s perspective, it is equity + debt - cash.
I deliberately did not include minority interest, cash equivalents etc. Wanted to keep the explanation simple.
 
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