What Affects Enterprise Value?
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- čas přidán 27. 07. 2024
- You’ll learn what affects Enterprise Value, and what does not, in this tutorial - and why it’s far more accurate to say that some changes simply affect Enterprise Value by less than *other changes*.
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Table of Contents:
6:48 Excel Demonstration of Factors That Impact Enterprise Value
10:45 Recap and Summary
QUESTION: If raising additional debt or equity, repaying debt, repurchasing shares, issuing dividends, and so on, all do not affect Enterprise Value, what DOES affect a company’s Enterprise Value?
To answer this question, you have to go back to the definition of Enterprise Value: the value of a company’s core business operations to ALL the investors in the company
The second part is straightforward, but what does “the value of the core business operations” mean?
ANSWER: The sum of the Present Value of a company’s Unlevered Free Cash Flows, plus the Present Value of its Terminal Value.
So a discounted cash flow (DCF) analysis gives you a company’s implied Enterprise Value - what it should be worth if your assumptions are correct.
So if something affects the company’s Unlevered Free Cash Flows, its Terminal Value, or both, it will affect the company’s Enterprise
Value as well.
The most common factors that affect Enterprise Value are expectations of higher or lower revenue growth or higher or lower margins in the future.
Example 1: The company wins a major contract with a new customer.
Example 2: The company’s expansion strategy into Southeast Asia succeeds more quickly than expected.
Example 3: The company closes down an unprofitable division, boosting its margins.
Example 4: The company negotiates a better supplier contract, boosting its margins.
All these changes are operational in nature, affect the company’s core business, and change its future Unlevered Free Cash Flows, so they would also impact its Enterprise Value.
Other items, such as changes in expectations for Capital Expenditures, Working Capital, and non-cash adjustments such as D&A could also affect Enterprise Value…
BUT they will make a fairly small impact next to differences in revenue growth and operating margins.
These items also tend to stay in fairly narrow ranges, as percentages of revenue, over time, whereas revenue growth and operating margins can swing around wildly.
If you go into Excel and try changing different assumptions in a DCF, including the company’s targeted debt/capital or debt/equity ratio, you’ll see that revenue growth and margins affect Enterprise Value by far more than almost anything else.
Summary
So *in theory*, changes such as more or less debt or equity will not affect Enterprise Value - only operational changes such as expectations of higher/lower growth or margins will.
But *in reality*, capital structure changes will still affect Enterprise Value, but by FAR LESS than operational changes.
So you’ll see small changes in Enterprise Value when going from a 10% debt / total capital ratio to 20%...
…but you’ll see MUCH bigger changes if, say, future revenue growth goes from 10% to 20%.
RESOURCES:
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Once again, a great video. Amazing source of information, thanks a lot M&I !!
Thanks for watching!
Thank you for this video. This is the most fascinating topic in the company valuation to me.
Thanks for watching
Excellent video Brian, Makes me wonder are if all those extra hours and effort put into building complex PPE and Debt schedules worth it , given their low impact on the EV ?
The short answer is no, but bankers love to do pointless work. Complex models are rarely "worth it," but sometimes people like to talk themselves into believing they are.
Thank you for this video. Can you make a video on residual income ?
We have something like that in our Bank Modeling course. It's such a specialized topic that we probably won't cover it here.
Always high quality stuff here, thanks a lot, Brian!
So, the Enterprise Value is equal to the present value of the future unlevered FCFs.
Is the Equity Value then equal to the present value of the future Net Income or dividends?
Equity Value is equal to the Present Value of Levered FCFs (so neither Net Income nor Dividends, as you must also factor in CapEx, Working Capital, non-cash add-backs, etc.). The main difference is that you also include the interest expense and mandatory debt principal repayments.
Thanks!
Thanks a lot. Aren't you double counting the last year contribution when in the DCF calculation, you count that year's FCF in the "(+) Sum of PV of Free Cash Flows" part and also count that year's Ebitda in the "Baseline Terminal Value" part?
No. The Terminal Value represents the PV of the company's cash flows from the end of Year 14 or beginning of Year 15 onward. The multiple is what someone else is willing to pay for the company at that stage for the company's cash flows starting at the beginning of Year 15.
Thank you for the great video!
I just have one quick question.
If an interview question is: you spend $1000 to build a new factory (capex), then how does it affect EV. Does it stay the same or increase? If so, by how much?
Enterprise Value increases by $1000 because you're swapping a non-core assets (Cash) for a core-business assets (the factory, which counts as PP&E).
@@financialmodeling But wouldn't an investment in PP&E (CAPEX) decrease my FCF and that decrease would reduce my Enterprise value?
If I do think about this scenario as in your answer, I do understand it but if I think about it in a more "formula way" I do not understand it. I mean, Capex would be an investing activity and reduce my FCF (and so my enterprise value). Where is my mistake?
Hope you can help me! Thx
@@undercover1923 Your thinking is incomplete. Yes, extra CapEx reduces UFCF in the short-term, but that investment will increase revenue and cash flow over the long-term, presumably by more than the upfront investment amount. You have to think about the whole cycle of an investment or spending process and the after-effects.
Hey. Why did you take DA, NWC and Capex as a % of revenue. I don't think that this is an appropriate way to calculate these figures.
If you talk about revenue|cost drivers like new contracts or some kind of optimisation it all will affect revenue (margins) but there will be no effect on DA and Capex (fixed assets remain the same).
So if revenue (or margins) will grow from 100 to 130 due to new contracts there will be 0 effect on DA and Capex and FCF will be higher compared to your calculations (cause of % revenue).
This is my point of view =)
Thnak you for videos you make. Keep going =)
My point of view is that your comment doesn't relate to the core purpose of this tutorial: the factors that influence Enterprise Value.
You can debate how to project items like CapEx, and some people will use different methods, such as making CapEx drive revenue, making revenue drive CapEx, using a % growth rate, etc.
But the real point is that IF something affects CapEx (or those other operational items), it will affect the company's Enterprise Value.
A company's revenue growing will most definitely impact its CapEx. Higher sales will mean that the company has more funds available to re-invest in its business, and it will almost certainly do so if it can find useful ways to do that.