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I'm in the process of reading thru "One Up on Wall St.", and one of the examples has left me confused. If someone could offer some help, I would greatly appreciate it.

In the section on "Cash Position" from the "Some Famous Numbers" chapter, Lynch discusses an example involving Ford. In the example, Ford was selling for \$38, but the balance sheet was showing over \$8B in cash net of long term debt. Lynch calculated there to be effectively \$16.30 of available cash for each outstanding share. Based on this, Lynch states that the P/E should be based on a \$21.70 share price (\$38-\$16.30), not the \$38 street price.

I'm confused about why he subtracted the cash value from the stock price. Was he rationalizing that the \$38/share was only buying \$21.70 worth of risk?

What would be other examples or situations when this rationale is applicable?

Thanks,
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What Lynch was doing was computing the enterprise value of the company. This is determined by adding the market value of the equity to debt and preferred stock, then subtracting cash and cash equivalents. Think of this as the theoretical price that an acquirer would be paying for the company.
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When doing this calculation on a company yourself you should be careful that your not subtacting the cash and adding it to a business value leftover which is drastically weakened without thew cash.

Total Value = cash + business value(discounted future cash flows??? or P/E???)

If you subtract all the cash, maybe that would leave the business in a reduced competitive position possibly. Maybe you don't see the business with a strong growth position without all that cash for example. Futre cap ex may need to come from debt instead of its own cash; if you subtract all of it.

Duane
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Duane:

A fair comment. It's probably best to subtract just the excess cash, the amount above what is needed to run the business. This varies by industry. Many really profitable companies just build cash like crazy, consistently, and cannot reinvest it all into their business.

The Hynie
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Hi,

Here's an article about Enterprise value:
http://www.fool.com/DripPort/2002/dripport020221.htm

Eric