Impact of Share Repurchase on Total Enterprise Value of a Firm

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exemplaria

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That wasn't an option. The options were "no violation" and 3 other violations. The correct one was "material non-public information". Many people argued the correct one was "didn't have a reasonable basis", but they're wrong. For the record, I put "no violation", because I'm a slimy guy who likes to break the rules.
 
torontosimpleguy Wrote:
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> Actually we can calculate it.
>
> Expected value of debt is $25M and book value of
> debt is $50M. Thus the probability of default is
> 50%.
>
> Scenario 1, probability 50% of bankruptcy, market
> value of company $0M = $50M - $50M.
>
> Scenario 2, probability 50% of solvency, market
> value of company $100M = $50M + $50M.
>
> Thus expected market value of whole company is
> (0.5*0+0.5*100 = 50M) dollars and the expected
> market value of equity is $25M.


This is straying a bit from my area of expertise (and I haven't read all of the thread) but there are some things that should be clarified.

Toronto - you said "Expected value of debt is $25M and book value of debt is $50M. Thus the probability of default is 50%."

This is not correct. The probability of default is better characterized as the probability that even $1 that is due does not get paid. The $25 million haircut on the trading value of the debt would be better referred to as expected loss given a default by the company.

Going from there, your scenario analysis would not be correct. You don't use the lower market value of the debt to calculate the market value of the company... the lower value of the debt is the result of the calculated market value of the company's earning power and assets.

In a case where the debt is trading at such a deep discount, the company is likely already in default and in bankruptcy. If you have book value:

Assets = 100
Debt= 50
Equity = 50

and the Debt is trading at 25, that implies that the assets are worth 25 and the company has no equity.
 
"Super I", you are right and wrong at the same time IMHO.

You are right that I made some simplified assumptions regarding to �probability of default�.

You are wrong that �company has no equity� (as Ted put it, "the equity holders are paying $50M for something worth $25M" or even zero here).

And Ted was wrong when he said that �no scenario analysis� is involved here, which I was arguing about.

Regarding to right scenario analysis I realized that we don�t have enough info to describe it here. We have to have equity�s value for each scenario and use them to calculate the expected value of equity that gives theoretical value for market capitalization IMHO.
 
Btw, "Super I", I know you are good in accounting. Do company pay dividend to the treasury stock (we had here an argument before)?
 
Toronto -


As I said, this is not my area of strength, but I still disagree. When Ted said "the equity holders are paying $50M for something worth $25M" (and I did not read the context of that post, so I'm sorry if I misinterpret it) he was wrong. The equity holders PAID $50 million. Book value will stay the same irrespective of market value, probability of default, etc. If debt is selling at a 50% discount and represented 50% of the book capitalization, I stand by what I said.

You are 100% correct about scenario analysis, but that effectively already has been done to produce the 50 discount on debt. It took the form of say, 50% probability that the company will have a liquidation value of $37.5 million, 50% that it will be $12.5 million for an expected value of the $25 million, which means ZERO equity in either case.

You don't write down debt that steeply until equity is completely blown thru.

Now if debt were trading at $45 million it would be a different story. That is most likely the result you see when there are still some possible scenarios where the equity has some value weighted against full write-off and loss given default scenarios.


I'm not sure if we really disagree conceptually. I think I'm just taking a leap based on the particular numbers of the example that we're using.
 
"Super I", Ted was referring to market value of equity not the debt.

Initial assumptions are,

Market capitalization is $50M.
Market value of debt is $25M.
Book price of debt is $50M.

Therefore it's impossible that 'company has no equity' if market capitalization is $50M.
 
Regarding to market value of debt I already used it to produce 'probability of default' for scenario analysis. But later I realized that I still don't have info as I said.
 
Actually I think I may have enough info!

Here is simple equation assuming that equity�s value is the same for both scenarios.

X � equity�s value if solvency.

(X-50) � equity�s value if bankruptcy.

50 � market capitalization.

(X-50)*0.5+X*0.5=50

X = 75

Hope I�m right here.
 
Toronto -

Just saw question on treasury stock. Answer is no. Dividends are only paid on shares outstanding.

I didn't see that Ted said market value and not book, so I was incorrect before.

I still think that your calculations are off. If the market value of the equity is $50 and the debt is $25 then I still think the market cap of the company is just the sum of the two and the equity market value the $50.

Your calculations already have been done, and you're effectively taking them twice.

I see this as a situation like what tech may have faced 5 years ago.

Say for example you have an internet start up with limited hard assets, Debt of $50 million (book) and equity whose market value has exploded to $500 million. Suddenly, the internet bubble collapses and the equity loses 90% of its value, dropping back to $50 million, and scenario analysis shows that in an extreme case there is no value at all in the company and the debtholders will see nothing. Based on this the market starts to unload the debt and its value drops to $25 million. You don't then go and take further reductions based on the reductions. The market value of the equity IS the expected market value of the equity, and all values reflect all available information. Because debt value is contingent on equity value (first loss) you would never apply the debt haircut to estimate the value of the equity.
 
Super I Wrote:
-------------------------------------------------------
> I still think that your calculations are off. If
> the market value of the equity is $50 and the debt
> is $25 then I still think the market cap of the
> company is just the sum of the two and the equity
> market value the $50.

We understand market cap differently. I include into it only the expected value of equity and you want to add somehow debt there.

Look at my calculation again with this distinction in mind.
 
torontosimpleguy Wrote:
-------------------------------------------------------

> We understand market cap differently. I include
> into it only the expected value of equity and you
> want to add somehow debt there.
>
> Look at my calculation again with this distinction
> in mind.

Even if you're only talking about equity, if you're given that the market value of equity (as we agreed, market value not book value) is $50 million, then the market value of equity is $50 million. The example wasn't "lets' assume we have a company with FMV debt of $50, FMV equity off $50 and suddenly teh debt value drops in half so what is the new equity FMV. We were already told the equity market value given the 50% cut in debt value.

Forget this case for a second. Do market value and market cap have different definitions?
 
Super I Wrote:
-------------------------------------------------------
> Forget this case for a second. Do market value
> and market cap have different definitions?

Market cap is strictly about equity (in this example). Market value can be either about debt, equity, or the whole company.
 
torontosimpleguy Wrote:
-------------------------------------------------------
> Super I Wrote:
> --------------------------------------------------
> -----
> > Forget this case for a second. Do market value
> > and market cap have different definitions?
>
> Market cap is strictly about equity (in this
> example). Market value can be either about debt,
> equity, or the whole company.


That's not my question (which was kind of rhetorical). What' s the difference between market value of equity and market cap? I think the answer is that there isn't any. So if you're given aa scenario aand told that market value of equity is X then the market cap is still X irrespective of what else you see on the balance sheet.
 
Knowing equity $75, I can calculate market value for the whole company now.

Scenario 1 (solvency) � company�s value is $75 (equity) + $50 (debt�s book).

Scenario 2 (bankruptcy) � company�s value is $75 (equity) - $50 (debt�s book).

The company�s market value is,

0.5*125+0.5*25=$75

==================================================

Regarding to equity.

It is equal to $75 when company is solvent (i.e. 'market value' provided this particular condition).

It is equal to $25 when company is bankrupt (i.e. 'market value' provided this particular condition).

It is equal to $50 for both scenarios (i.e. 'market value' provided average possibilities of both these conditions).
 
Moreover, we could verify that. Market values of debt and equity are $25 and $50 (given).

$25 - market value of debt
$50 - market value of equity
===================
$75 - market value of the whole company
 
I have no problem with being insulted from time to time. My position is that it's okay to dish it out as long as you can take it.

I'll drop this right now.. as I said up front this isn't one of my stronger areas and I didn't take the time to read the whole thread so I may have missed some of the underlying parts of the question before i jumped in.
 
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