Investment Banking puzzles, solved step by step

Puzzles
100
Traced to a firm
36
Topics
12
Hard
29
Topic
All topicsProbability7Mental maths and counting11Growth and compounding9Valuation riddles11Logic and brainteasers11Rates, risk and options9Estimation and market sizing7Accounting riddles9Expected value and games7Enterprise value and dilution6Deal maths6DCF and cost of capital7
Level
AnyWarm upCoreHard
Source
AnyReported at a firmStandard
Showing 1–1 of 1 · filtered from 100Clear filters
  1. 044A company finds Rs 10 crore of cash lying on the street. What happens to its enterprise value and its equity value?Enterprise value and dilutionWarm upUBSAnonymous interview candidate in · 2024

    Try it first

    What happens to enterprise value?

    Show the worked solution

    Enterprise value stays the same and equity value rises by Rs 10 crore. Shareholders own the extra cash, so their equity is worth Rs 10 crore more. Enterprise value is equity plus debt minus cash: equity is up 10 and cash is up 10, so EV does not move. EV measures the operating business, and picking money up off the street does not change what that business earns. Ignoring tax on the windfall keeps the numbers clean.

    What is enterprise value actually measuring?

    Think of buying a shop whose till holds Rs 10,000. You would pay for the business plus the cash in the till, and the cash is worth exactly its face value to you, no more and no less. Enterprise value prices the operating business on its own, so cash, which is worth its face value to whoever holds it, is taken out of the bridge. Equity value is what shareholders own, and they own both the business and the cash.

    Cash and equity rise together; enterprise value does not moveRs croreBeforeAfterEquity value500510+ Debt300300- Cash5060= Enterprise value750750Shareholders own the extra cash; the business is unchangedWhat moved, in EV termsEquity +10+10Debt0Cash +10-10Change in enterprise value0
    Finding Rs 10 crore lifts equity value from Rs 500 crore to Rs 510 crore and cash from Rs 50 crore to Rs 60 crore, and because cash is subtracted in the bridge, enterprise value stays at Rs 750 crore.

    How does the bridge move?

    Take a company with equity worth Rs 500 crore, debt of Rs 300 crore and cash of Rs 50 crore, so enterprise value is Rs 750 crore. Find Rs 10 crore: cash becomes Rs 60 crore and equity Rs 510 crore, and EV is 510 plus 300 minus 60, still Rs 750 crore. Nothing in the operating business changed, so multiples of EBITDAEarnings before interest, tax, depreciation and amortisation: a rough measure of the cash profit the operating business produces. or revenue do not change either.

    The relationship
    EV=E+D−C:500+300−50=750  →  510+300−60=750EV = E + D - C: \quad 500 + 300 - 50 = 750 \;\to\; 510 + 300 - 60 = 750
    Eequity value, what the shareholders own
    Ddebt
    Ccash, subtracted because it is not part of the operating business
    What it says in wordsEquity and cash rise by the same amount, so their effects on enterprise value cancel.

    What assumptions should you say out loud?

    Two. First, tax: the windfall is probably taxable income, so at a 25% rate equity and cash each rise by Rs 7.5 crore rather than Rs 10 crore. Whatever amount sticks, cash and equity move together and enterprise value stays put. Second, the cash sits idle. If the company used it to repay debt, EV would still not change, but the split between lenders and shareholders would. Naming both shows the interviewer you know which line each event touches.

    Where candidates lose it

    The common wrong answer is that enterprise value rises by Rs 10 crore because the company is worth more. The owners are richer, but the operating business is not, and EV only measures the business.

    The opposite slip is saying EV falls because cash is subtracted. That forgets equity rises by the same amount. Walk the bridge line by line and the two moves cancel.

    What the interviewer asks next

    • The company uses the Rs 10 crore to repay debt. What happens to EV and equity value?
    • The company issues Rs 100 crore of new shares for cash. What happens to EV?
    • Why might a buyer pay less than face value for cash trapped in a foreign subsidiary?

    Asked at UBS, Investment Banking, Anonymous interview candidate in, 2024 (Wall Street Oasis): explain the assumptions behind it - if pick up 10 bucks, what happens to EV