Share Selling feature: error in financial logic
Posted: Thu Apr 24, 2014 8:21 am
I'm enjoying the latest alpha build and think the 'sell shares' feature adds an interesting dynamic, giving players the option of cash up front in exchange for a piece of the equity in the prison. However, it appears the calculation as implemented currently is a bit off, from a financial standpoint:
Enterprise value (or 'firm value') is the total value of a business's assets and operations that can produce an economic return--or, more simply, the price you would pay to acquire it. For a public company, this is equivalent to the total value of its outstanding stock (market cap) plus debt, minus cash. Cash is backed-out because it's uninvested capital that doesn't produce an economic return: you wouldn't pay cash to acquire cash.
Equity value is the value of a company attributable to its owners or shareholders--outstanding debt is not included. Cash is, however, because its value is immediately available to its owners (or acquirers, ie to pay down debt).
"Valuation" in real life can refer to either equity value or enterprise value. In the game, your prison's valuation is based on the value of its assets and operations, less outstanding bank loans, plus cash--in other words, equity value. When your prison sells stock, however, total cash is subtracted from the valuation when calculating the issuance proceeds. I'm not sure that makes financial sense: share value should be calculated based on the total valuation, including cash.
This also allows an exploit / 'gamey' tactic a player can use to pump-up share value before selling: just burn any extra cash on expensive objects. I know it's not necessarily intuitive why cash is excluded from enterprise value and included in equity value, but just think--if it weren't, CEOs could easily pump their stock price by dumping every spare dollar back into the business. No company would ever have cash on their balance sheet.
Enterprise value (or 'firm value') is the total value of a business's assets and operations that can produce an economic return--or, more simply, the price you would pay to acquire it. For a public company, this is equivalent to the total value of its outstanding stock (market cap) plus debt, minus cash. Cash is backed-out because it's uninvested capital that doesn't produce an economic return: you wouldn't pay cash to acquire cash.
Equity value is the value of a company attributable to its owners or shareholders--outstanding debt is not included. Cash is, however, because its value is immediately available to its owners (or acquirers, ie to pay down debt).
"Valuation" in real life can refer to either equity value or enterprise value. In the game, your prison's valuation is based on the value of its assets and operations, less outstanding bank loans, plus cash--in other words, equity value. When your prison sells stock, however, total cash is subtracted from the valuation when calculating the issuance proceeds. I'm not sure that makes financial sense: share value should be calculated based on the total valuation, including cash.
This also allows an exploit / 'gamey' tactic a player can use to pump-up share value before selling: just burn any extra cash on expensive objects. I know it's not necessarily intuitive why cash is excluded from enterprise value and included in equity value, but just think--if it weren't, CEOs could easily pump their stock price by dumping every spare dollar back into the business. No company would ever have cash on their balance sheet.