Enterprise / Equity Value

Question 1

Enterprise Value Definition

Answer 1

The value of a company’s core business operations (Net Operating Assets) to ALL the investors in a company (Equity, Debt, Preferred, and possibly others)

So, excludes Non-Operating Assets, such as Cash and Financial Investments, and Non-Operating Liabilities, such as Debt

Does not change with capital structure (% of Equity versus Debt)

Changes only if Net Operating Assets changes; if it does, both NOA and TEV change by the same amount

Question 2

Equity Value Definition

Answer 2

The value of EVERYTHING a company has (Net Assets), but only to Equity Investors (common shareholders)

i.e. the value of shareholders’ interest

Changes only if Common Shareholders’ Equity Changes; if it does, both CSE and Equity Value change by the same amount

Question 3

Enterprise Value Formula

Answer 3

Enterprise Value = Market Value of Assets - Market Value of Liabilities - Non-Operating Assets + Liability and Equity Items That Represent Other Investor Groups

E.g., subtract Equity Investments (Non-Core / Non-Operating), and add Noncontrolling Interests (represent another investor group, beyond the common shareholders)

Also, EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash

Question 4

Equity Value Formula

Answer 4

Three ways to calculate Equity Value

1) Equity Value = Shares outstanding * Current share price (for publicly traded cos)
2) Equity Value = Market Value of Assets - Market Value of Liabilities
3) The company’s valuation in its last round of funding, or its valuation in an outside appraisal (for private companies)

Question 5

Examples of Non-Operating Assets

Answer 5

• cash
• financial investments, such as stocks and bonds
• owned properties from which the co earns rental income
• side businesses that earn income for the co
• assets held for sale and assets associated with discontinued operations
• equity investments or associate companies, which represent minority stakes in other companies
• Net Operating Losses (NOLs), which are a component of the Deferred Tax Assets

An Asset is Non-Core or Non-Operating if the co doesn’t need that Asset to sell products/services and deliver them to customers

Question 6

Examples of Operating Assets

Answer 6

• PP&E
• Inventory
• Accounts Receivable
• Deferred Revenue

Question 7

Two step process for answering Equity and Enterprise Value questions:

Answer 7

1) Does CSE change?

If so, then Equity Value changes by the amount that CSE changes. If not, then Equity Value does not change.

2) Do Net Operating Assets (NOA) change?

If so, then Enterprise Value will change by the amount NOA changes. It doesn’t matter which investor group was responsible because Enterprise Value reflects all investors.

Question 8

Examples of Operating Liabilities

Answer 8

-deferred revenue

Question 9

Is Enterprise Value capital structure-neutral?

Answer 9

Instead of saying, “Enterprise Value stays the same regardless of capital structure, but Equity Value changes as the capital structure changes,” it’s better to think of it as “Enterprise Value is less affected by capital structure than Equity Value”

Think about WACC and the all-important formula

Question 10

Examples of Liability and Equity Items That Represent Other Investor Groups

Answer 10

• Debt
• Preferred Stock
• Capital Leases
• Noncontrolling Interests
• Unfunded Pensions
• (potentially) Operating Leases

Look at Balance Sheet for this stuff

Question 11

What do you pair with Enterprise Value?

Answer 11

Revenue, EBIT, EBITDA, and EBITDAR

Question 12

What do you pair with Equity Value?

Answer 12

Net Income (P / E is the multiple)

Question 13

What does “Free Cash Flow” reflect?

Answer 13

How much discretionary cash flow a company generates, after interest but before debt principal repayments?

EBIT and EBITDA are approximations of this cash flow; Free Cash Flow based metrics move us closer to the real thing

Question 14

How do you calculate Free Cash Flow?

Answer 14

Free Cash Flow = Cash Flow from Operations - CapEx (assuming CFO deducts the Net Interest Expense, Taxes, and the full Lease Expense)

It tells you how much cash flow the company’s core business is generating on a recurring basis … i.e., how much Debt principal the co could repay, or how much it could spend on activities such as acquisitions, dividends or stock repurchases

Multiples: P / FCF per Share; or Equity Value / FCF

FCF reflects co’s capital structure, which you don’t necessarily want

Question 15

How do the main types of FCF differ?

Answer 15

1) Investor groups

2) Treatment of Debt

Question 16

Unlevered Free Cash Flow

Answer 16

Discretionary cash flow available to All Investors (as if the co did not pay interest on Debt or Preferred Dividends)

Aka Free Cash Flow to Firm

You don’t start with CFO b/c you must exclude or “add back” the Net Interest Expense

Starting point is NOPAT = EBIT * (1 - Tax Rate)

NOPAT + D&A and sometimes other non-cash adjustments +/- Change in Working Capital - CapEx

Normally used in DCF valuations b/c it lets you evaluate a co while ignoring its capital structure

Multiple: TEV / UFCF

Question 17

What is Free Cash Flow?

Answer 17

Discretionary cash flow available only to Equity Investors (i.e. how much discretionary cash flow does the company generate, after interest but before debt principal repayments)

It tells you how much cash flow the company’s core business is generating on a recurring basis … i.e., how much Debt principal the co could repay, or how much it could spend on activities such as acquisitions, dividends or stock repurchases

Useful for standalone co analysis (as opposed to comparing, given that it reflects capital structure) and determining a company’s Debt repayment capacity

Multiples: P / FCF per Share; or Equity Value / FCF

FCF reflects co’s capital structure, which you don’t necessarily want

Question 18

Levered Free Cash Flow

Answer 18

Discretionary cash flow available only to Equity Investors (i.e. discretionary cash flow generated AFTER servicing ALL of its debt-related expenses)

Net Income to Common + D&A and sometimes other non-cash adjustments +/- Change in Working Capital - CapEx - (Mandatory?) Debt Repayments + Debt Issuances(?)

Big differences compared to UFCF: 1) Net Inc is starting point, 2) Debt Repayments and Debt Issuances should factor in, somehow (people disagree on how)

Not sure useful because people disagree on how to define it, but it could be used in a levered DCF and it may better represent the Net Change in Cash

Multiple: P / Levered FCF per Share; or Equity Value / Levered FCF

Question 19

Main components of UFCF

Answer 19

Ignores Net Interest Expense, Preferred Dividends, and Other Income / (Expenses) and includes only the company’s core business revenue and expenses

• Revenue
• Cogs and OpEx
• Taxes
• Depreciation & Amortization
• Change in Working Capital
• Capital Expenditures

Question 20

What does UFCF represent?

Answer 20

How much discretionary cash flow does the company generate, before both interest expense and debt principal repayments

Question 21

What does Levered FCF represent

Answer 21

How much discretionary cash flow does the company generate, AFTER servicing ALL of its debt-related expenses

Question 22

If the denominator of a TEV-based multiple does not deduct an Income Statement expense, then the numerator should add its corresponding Balance Sheet line item

Answer 22

Idk if worth studying

E.g. Preferred Dividends are excluded in TEV-based metrics because Preferred Stock is added in the TEV calculation

E.g. Interest on Capital Lease Liabilities is excluded in TEV-based metrics because Capital Leases are added in the TEV calculation

Question 23

How do you decide whether to pair a metric with Equity Value or Enterprise Value?

Answer 23

If a metric does not deduct Net Interest Expense or Preferred Dividends, pair it with Enterprise Value

If a metric does deduct Net Interest Expense and Preferred Dividends, pair it with Equity Value

Question 24

What does Book Value pair with?

Answer 24

Equity Value / Book Value, or P / BV

Tells you how efficiently a co has used its Equity, both internally generated and externally raised, to grow

Similar to TEV / IC but corresponds only to Equity Investors

Means little to most companies, because market values not linked directly to Balance Sheets

Question 25

What does Net Operating Assets pair with?

Answer 25

TEV / NOA

Question 26

What does Invested Capital pair with?

Answer 26

TEV / IC

Tells you how valuable a company is relative to the cumulative capital it has raised (or generated) over time

Tells you how efficiently a co is using its capital, and tends to correlate with ROIC

Question 27

Consumer/Retail Multiples

Answer 27

The valuation multiples are all standard, and EBITDAR and the matching valuation multiple are both common under U.S. GAAP when some companies rent their stores, and others own them.

Important operating metrics include Same-Store Sales, Inventory Turnover, Sales per Store, and Sales per Square Foot or Square Meter.`

Question 28

Tech Multiples

Answer 28

The multiples are standard for established companies, but for pre-revenue startups and
mobile/gaming companies, you’ll see metrics like Unique Visitors, Monthly Active Users, Mobile Users, and Subscribers, all of which pair with Enterprise Value.

Question 29

Why do you never project Equity Value or Enterprise Value?

Answer 29

They represent past results as well as future expectations as of the valuation date

Question 30

Pensions in Enterprise Value

Answer 30

UNLIKELY to come up

Only “Defined-Benefit” pension plans matter - plans where co promises to pay retired employees specific amts in future, and co is responsible for setting aside the funds and investing them appropriately

You should add the Unfunded or Underfunded portion in the TEV bridge because the employees represent another investor group in this case

They agree to lower pay and benefits today in exchange for fixed payments once they retire, and the company must fund the pension and invest funds appropriately

Question 31

Capital Leases

Answer 31

• Debt-like items that companies use to acquire equipment, property, factories, and other PP&E
• there are Interest Expenses and Depreciation associated with Capital Leases and their corresponding Assets, and metrics like EBITDA already exclude or “add back” these expenses
• Therefore, always add Capital Leases in the Enterprise Value bridge and count them as Debt-like items

Question 32

Operating Leases

Answer 32

Under both IFRS and GAAP, if you add Operating Leases in the TEV bridge, then you must pair TEV with metrics that exclude or “add back” the full Lease Expense. If you do NOT add Operating Leases, then you must deduct the full Lease Expense.

Under GAAP, we normally do NOT count Operating Leases in the TEV bridge so that EBIT and EBITDA remain valid metrics in the TEV/EBIT and TEV/EBITDA multiples. If you do count Operating Leases, you must use EBITDAR and TEV Including Operating Leases / EBITDAR instead.

Question 33

Net Operating Losses (NOLs)

Answer 33

Accumulate when a company records negative Pre-Tax Income

The off-Balance Sheet NOL increases by -Pre-Tax Income, and the Deferred Tax Asset increases by -Pre-Tax Income * Tax Rate

When co finally records positive Pre-Tax Income, it can use these NOLs to reduce its Taxable Income, thereby reducing its Cash Taxes

Question 34

NOLs / Enterprise Value

Answer 34

In the Enterprise Value bridge calculation, you subtract the on-Balance Sheet NOLs within the DTA, counting them as Non-Operating Assets

By contrast, other components of the DTA are closer to being “core” to the business

Question 35

What does Equity Value mean?

Answer 35

Equity Value represents the value of EVERYTHING a company has (its Net Assets) but only to EQUITY INVESTORS (i.e. common shareholders)

Question 36

What does Enterprise Value mean?

Answer 36

Enterprise Value represents the value of the company’s CORE BUSINESS OPERATIONS (its Net Operating Assets) but to ALL INVESTORS (Equity, Debt, Preferred, and possibly others)

Question 37

Why do you use both EqVal and TEV?

Why do you look at both EqVal and TEV?

Answer 37

Actions taken by one investor group affect all the other groups

If a company raises Debt, that also affects the risk and potential returns for common shareholders

____

Enterprise Value represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise Value represents its true value.

Question 38

Why do you pair Net Assets with Common Shareholders in Equity Value, but Net Operating Assets with All Investors in Enterprise Value?

Answer 38

• CSE can be generated internally (via Net Income) or raised externally (Stock Issuances), so the co can use it for both Operating and Non-Operating Assets
• But if co raises funds via outside investors (Debt, Pref Stock), most likely it will use those funds to pay for Operating Assets

Question 39

Difference between calculating Current Enterprise Value and Implied Enterprise Value?

Answer 39

Current is calculated using the formula

Implied is calculated based on valuation methodologies, such as DCF, comparable public companies, and precedent trx

Question 40

Why might a company’s Current Enterprise Value be different from its Implied Enterprise Value?

Answer 40

Everyone agrees on a company’s current Cash Flow, but you might disagree with the market on the Discount Rate or Cash Flow Growth Rate

Question 41

Can a company’s Equity Value ever be negative?

Answer 41

• Current Equity Value - NO
• Implied Equity Value - YES (e.g. if TEV is $0 and it has more Debt than Cash) … but typically, you describe it’s Equity Value as $0 in cases like this

Question 42

Can a company’s Enterprise Value ever be negative?

Answer 42

Yes. Both Current and Implied Enterprise Value could be negative – for example, a company might have Cash that exceeds its Current Equity Value and no Debt. And your Implied Enterprise Value might be the same as, or close to, its Current Enterprise Value.

Question 43

You estimate a co’s Implied Value with Company Value = Cash Flow / (DR - CFGR)

Does this give you Implied Equity Value or Implied Enterprise Value?

Answer 43

It depends on the type of Cash Flow and Discount Rate you are using

Unlevered FCF + WACC –> Implied Enterprise Value

Levered FCF or FCF to Equity + Cost of Equity –> Implied Equity Value

Question 44

Is it possible for a single change to effect both Current Equity Value and Current Enterprise Value?

Answer 44

Yes. For this to happen, Net Operating Assets must change, and Common Shareholders’ Equity must also change.

E.g. if the company issues $100 of Common Stock to fund the purchase of $100 in
PP&E, both Eq Val and TEV will increase by $100.

Question 45

Why does Enterprise Value NOT necessarily represent the “true cost” to acquire a company?

Answer 45

First, because the treatment of the seller’s existing Debt and Cash differs based on the terms of the deal. The buyer may not necessarily “repay” the seller’s Debt – it could instead refinance it and replace it with new Debt – and it may not “get” all the seller’s Cash.

Also, the buyer has to pay additional fees for the M&A advisory, accounting, and legal services, and the financing to acquire another company, and those are not reflected in its Enterprise
Value.

Question 46

How do you calculate EBIT and EBITDA for a public company?

Answer 46

With EBIT, start with co’s Operating Income on its Income Statement and then add back any non-recurring charges that have reduced Operating Income

With EBITDA, you do the same thing and then add Depreciation and Amortization from the company’s Cash Flow Statement

Question 47

How do you use Unlevered FCF and Levered FCF differently from normal Free Cash Flow?

Answer 47

• you normally use UFCF in DCF valuations b/c it lets you evaluate a co while ignoring its capital structure
• FCF is more useful for standalone company analysis and determining a company’s Debt repayment capacity
• LFCF is not very useful because of how much people disagree on its definition, but you could use it in a Levered DCF, and it may better represent the Net Change in Cash

Question 48

How do you decide whether to use Equity Value or Enterprise Value when you create valuation multiples?

Answer 48

• if the financial metric in the denominator of the valuation multiple deducts Net Interest Expense, then it pairs with Equity Value because the Debt investors can no longer be “paid” after they earn their interest
• if metric does not deduct Net Interest Expense, then it pairs with Enterprise Value

Question 49

What are the advantages and disadvantages of TEV / EBITDA vs. TEV / EBIT vs. P / E?

Answer 49

First, note that you never look at just one multiple when valuing companies. You want to evaluate companies across different multiples and methodologies to get the big picture.

But the interviewer will probably be annoying and press you on this point, so you can say that TEV / EBITDA is better in cases where you want to exclude the company’s CapEx and capital structure completely.

TEV/EBIT is better when you want to ignore capital structure but partially factor in CapEx (via the Depreciation, which comes from CapEx in previous years).

So, TEV / EBITDA is more about normalizing companies and more useful in industries where CapEx is not a huge value driver, while TEV / EBIT is better when you want to link CapEx to the company’s value (e.g., for an industrials company).

The P / E multiple is not that useful in most cases because it’s affected by different tax rates, capital structures, non-core business activities, and more; you use it mostly as a “check,” and since it’s a standard multiple everyone knows.

• Addtl note: EBIT is proxy for core, recurring business PROFITABILITY, before impact of capital structure and taxes; RBITDA is proxy for core, recurring business CASH FLOW FROM OPERATIONS, before the impact of capital structure and taxes.

Question 50

In the TEV / EBITDAR multiple, how do you adjust Enterprise Value?

Answer 50

If the denominator of a valuation multiple excludes or adds back an expense on the Income Statement, then the numerator should add the Balance Sheet item corresponding to that expense

EBITDAR is EBITDA + Rental Expense, so it adds back Rental Expense

Therefore, in TEV, you must add the company’s on-Balance Sheet Operating Leases

Question 51

Why do you NOT subtract Goodwill when moving from Equity Value to Enterprise Value? Co doesn’t need it to continue operating its business..

Answer 51

Goodwill reflects the premiums paid for previous acquisitions – if you subtracted it, you’d be saying, “Those previous acquisitions are not a part of this company’s core business anymore.” That’s true only if co has shut down or sold those other cos.

Question 52

Why do you subtract only part of a company’s Deferred Tax Assets (DTAs) when calculating Enterprise Value?

Answer 52

Deferred Tax Assets contain many different items, some of which are related to simple timing
differences or tax credits for operational items. But you should subtract ONLY the Net Operating Losses (NOLs) in the DTA because those are considered Non-Operating Assets (and they have some potential value to acquirers in M&A deals); they’re less related to operations than the rest of the items in a DTA.

Question 53

When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity Value?

Answer 53

Enterprise Value, because that’s how much the acquirer actually “pays” and includes the often mandatory debt repayment

Question 54

Why is it incorrect to use Market Value / EBITDA or EV / Net Income?

Answer 54

For any multiple, the denominator and numerator must either include or exclude leverage. In other words, both the numerator and denominator must relate to either all capital holders or all shareholders. Otherwise, comparisons across companies will not be “apples-to-apples”—they will be difficult to compare because different companies utilize different amounts of leverage.

Question 55

Why do you need to add Minority Interest to Enterprise Value?

Answer 55

• Whenever a company owns over 50% of another company, it is required to report the financial performance of the other company as part of its own performance.
• So even though it doesn’t own 100%, it reports 100% of the majority-owned subsidiary’s financial performance.
• In keeping with the “apples-to-apples” theme, you must add Minority Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary.

Question 56

Why do you subtract cash in the formula for Enterprise Value? Is that always accurate?

Answer 56

The “official” reason: Cash is subtracted because it’s considered a non-operating asset and because Equity Value implicitly accounts for it.

• The way I think about it: In an acquisition, the buyer would “get” the cash of the seller, so it effectively pays less for the company based on how large its cash balance is. Remember, Enterprise Value tells us how much you’d really have to “pay” to acquire another company.
• It’s not always accurate because technically you should be subtracting only excess cash - the amount of cash a company has above the minimum cash it requires to operate

Question 57

Could a company have a negative Enterprise Value? What would that mean?

Answer 57

1) Extremely large cash balance
2) Extremely low market cap

• common among co’s on bring of bankruptcy
• common among financial institutions

Question 58

How do you account for convertible bonds in the Enterprise Value formula?

Answer 58

If in-the-money, then you count them as additional dilution to the Equity Value; if they’re out of the money then you count the face value of the convertibles as part of the company’s Debt

Question 59

A company has 1 million shares outstanding at a value of $100 per share. It also has $10 million of convertible bonds, with par value of $1,000 and a conversion price of $50. How do I calculate diluted shares outstanding?

Answer 59

1. ($value of conv. bonds)/par value
2. Par value/conversion price
3. multiply 1 & 2

Note: We do not use the Treasury Stock Method with convertibles because the company is not “receiving” any cash from us.

Question 60

What’s the difference between Equity Value and Shareholders’ Equity?

Answer 60

Equity Value is the market value and Shareholders’ Equity is the book value. Equity Value can never be negative because shares outstanding and share prices can never be negative, whereas Shareholders’ Equity could be any value. For healthy companies, Equity Value usually far exceeds Shareholders’ Equity.

Question 61

Should you use the book value or market value of each item when calculating Enterprise Value?

Answer 61

you should use market value for everything. In practice, however, you usually use market value only for the Equity Value portion, because it’s almost impossible to establish market values for the rest of the items in the formula - so you just take the numbers from the company’s Balance Sheet

Question 62

Give me an example of how you might estimate revenue and expense synergies in an M&A deal.

Answer 62

With revenue synergies, you might assume that the Seller can sell its products to some of the Buyer’s customer base. So if the Buyer has 100,000 customers, 1,000 of them might buy widgets from the Seller. Each widget costs $10.00, so that is $10,000 in extra revenue.

There will also be COGS and possibly Operating Expenses associated with these extra sales, so you must factor those in as well. For example, if the cost of each widget is $5.00, then the Combined Company will earn only $5,000 in extra Pre-Tax Income.

With expense synergies, you might assume that the Combined Company can close a certain number of offices or lay off redundant employees, particularly in functions such as IT, accounting, and administrative support.

So if both companies, combined, have 10 offices, and management feels that only 8 offices will be needed after the merger, the combined rental expense will decline.

If each office costs $100,000 per year to rent, there will be 2 * $100,000 = $200,000 in expense synergies, which will boost the Combined Pre-Tax Income by $200,000.

Question 63

MOVE TO MERGER SECTION

Walk me through a merger model

Answer 63

In a merger model, you start by projecting the financial statements of the Buyer and Seller. Then, you estimate the Purchase Price and the mix of Cash, Debt, and Stock used to fund the deal. You create a Sources & Uses schedule and Purchase Price Allocation schedule to estimate the true cost of the acquisition and its effects.

Then, you combine the Balance Sheets of the Buyer and Seller, reflecting the Cash, Debt, and Stock used, new Goodwill created, and any write-ups. You then combine the Income Statements, reflecting the Foregone Interest on Cash, Interest on Debt, and synergies. If Debt or Cash changes over time, your Interest figures should also change.

The Combined Net Income equals the Combined Pre-Tax Income times (1 – Buyer’s Tax Rate), and to get the Combined EPS, you divide that by the Buyer’s Existing Share Count + New Shares Issued in the Deal.

You calculate the accretion/dilution by taking the Combined EPS, dividing it by the Buyer’s standalone EPS, and subtracting 1.

Question 64

An Acquirer with an Equity Value of $500 million and Enterprise Value of $600 million buys another company for a Purchase Equity Value of $100 million and Purchase Enterprise Value of $150 million.

What are the Combined Equity Value and Enterprise Value?

Answer 64

The Combined Enterprise Value equals the Enterprise Value of the Buyer plus the Purchase Enterprise Value of the Seller, so it’s $600 million + $150 million = $750 million.

You can’t determine the Combined Equity Value because it depends on the purchase method: Combined Equity Value = Acquirer’s Equity Value + Value of Stock Issued in Deal.

If it’s a 100% Stock deal, the Combined Equity Value will be $500 million + $100 million = $600 million, but if it’s 100% Cash or Debt, the Combined Equity Value = $500 million.

And if the % Stock Used is above 0% but less than 100%, the Combined Equity Value will be between $500 and $600 million.

Question 65

How do the Combined Equity Value and Enterprise Value relate to the purchase method?

Answer 65

The Combined Enterprise Value is not affected by the purchase method: Regardless of the % Cash, Debt, and Stock used, it’s always equal to the Buyer’s Enterprise Value plus the Purchase Enterprise Value of the Seller.

The Combined Equity Value is equal to the Buyer’s Equity Value plus the Value of Stock Issued in the Deal, which could range from $0 up to the Purchase Equity Value of Seller.

So if it’s a 100% Stock deal, the Combined Equity Value = Buyer’s Equity Value + Purchase Equity Value of Seller.

Question 66

How do the Combined Multiples change based on the purchase method?

Answer 66

Enterprise Value-based multiples do not change based on the % Cash, Debt, and Stock used because the Combined Enterprise Value is not affected by the purchase method, and EV-based metrics such as Revenue, EBITDA, and EBIT are also not affected by it.

Equity Value-based multiples will change based on the purchase method because the Combined Equity Value depends on the % Stock Used, and Equity Value-based metrics such as Net Income and Free Cash Flow are impacted by the Foregone Interest and Interest on New Debt.

Question 67

Steps to create a multiple

Answer 67

1) Calculate numerator: EqVal or Enterprise Value
2) Calculate denominator: financial metric (Sales, EBITDA, EBIT, net income) … normalize it (often when normalizing, earnings will go up, so taxes will also go up)

Question 68

Why don’t we just use cash flow multiples?

Answer 68

Because there are comparability issues - companies use slightly different accounting methods to set up their cash flow statements. To normalize them would take too much time.

Question 69

What do profitability based multiples measure?

Answer 69

EBIT, EBITDA and Net Income all measure a company’s profitability. And the corresponding valuation multiples measure company’s price in relation to profits.

Question 70

Common Valuation Multiples

Answer 70

TEV / Revenue
TEV / EBIT
TEV / EBITDA
P / E (Equity Value / Net Income, or Price per share / Earnings per share)

Multiples reflect a specific company attribute vis a vis its price.

Question 71

Balance Sheet Multiples

Answer 71

P / BV (Equity Value / Book Value)

• tells you how efficiently the company has used its equity, bot internally generated and externally raised, to grow

TEV / NOA

TEV / IC

• tells you how valuable a company is relative to the cumulative capital it has raised (or generated) over time

Question 72

In the Equity Value to Enterprise Value bridge, what do you do with equity investments and non-controlling interests?

Answer 72

In the equity value to enterprise value bridge, you subtract equity investments and add Non Controlling interests

Subtract equity investments because they are non-core or non-operating assets

Non controlling interests are added because they represent another investor group, beyond the common shareholders

Question 73

Why do we add Preferred Stock to get to Enterprise Value?

Answer 73

Preferred Stock pays out a fixed dividend, and preferred stock holders also have a higher claim to a company’s assets than equity investors do. As a result, it is seen as more similar to debt than common stock.

Question 74

Why do yo use both Equity Value and Enterprise Value?

Answer 74

Neither one is “better” or “more accurate” – they represent different concepts, and they’re
important to different types of investors.

Enterprise Value and TEV-based multiples have some advantages because they are not affected by changes in the company’s capital structure as much as Equity Value and Eq Val-based multiples are affected.

However, in valuation, one methodology might produce Implied Enterprise Value, while another might produce Implied Equity Value, so you will need to move between them to analyze a company.

Finally, you use both of them because actions taken by one investor group affect all the other groups. If a company raises Debt, that also affects the risk and potential returns for common shareholders.

Question 75

Why do you add Noncontrolling Interests (NCI) when moving from Equity Value to Enterprise Value?

Answer 75

First, these Noncontrolling Interests represent another investor group beyond the common shareholders: the minority shareholders of the Other Company in which the Parent Company owns a majority stake. The Parent Company effectively controls this Other Company now, so it counts these minority owners as an investor group.

Second, you add NCI for comparability purposes. Since the financial statements are consolidated 100% when the Parent Company owns a majority stake in the Other Company, metrics like Revenue, EBIT, and EBITDA include 100% of the Other Company’s financials.

Equity Value, however, includes only the value of the actual percentage the Parent owns.

So, if a Parent Company owns 70% of the Other Company, the Parent Company’s Equity Value will include the value of that 70% stake. But its Revenue, EBIT, and EBITDA include 100% of the Other Company’s Revenue, EBIT, and EBITDA

Question 76

Why do you subtract Equity Investments, AKA Associate Companies, when moving from Equity Value to Enterprise Value?

Answer 76

First, they’re Non-Operating Assets since the Parent Company has only minority stakes in these companies and, therefore, cannot control them.

Second, you subtract them for comparability purposes. Metrics like EBITDA, EBIT, and Revenue
include 0% of these companies’ financial contributions, but Equity Value implicitly includes the
value of the stake (e.g., 30% of the Associate Company’s Value if the Parent owns 30% of it).

Therefore, you subtract the Equity Investments when moving from Equity Value to Enterprise
Value to ensure that the numerator of TEV-based multiples – Enterprise Value – completely excludes Equity Investments, matching the metrics in the denominator that also exclude them.

Question 77

Should you add on-Balance Sheet Operating Leases in the Equity Value to Enterprise Value bridge?

Answer 77

You dont have to

But if you do, you have to pair TEV Including Operating Leases with EBITDAR; multiples such as TEV / EBIT and TEV / EBITDA are no longer valid because the denominators deduct the full Rental Expense

Question 78

At a high level, how do Pensions factor into the Enterprise Value calculation?

Answer 78

Only Defined-Benefit Pension plans factor in because Defined-Contribution Plans do not appear on the Balance Sheet.

Question 79

How do you use valuation multiples in real life?

Answer 79

Most often, you use them in “Comparable Company Analysis” or “Public Comps” when you find public companies similar to the one you’re analyzing and use their multiples to value your company.

For example, you might screen companies by geography, industry, and financial size so that they are similar to your company.

Then, you look at the growth rates of various metrics and their corresponding multiples to see how your company is currently priced.

For example, if the median EBITDA growth of this set of companies is 10%, and your company is growing at 20%, but your company’s TEV / EBITDA and the median TEV / EBITDA of the set are similar, then perhaps your company is undervalued.

If the companies are truly comparable, then they should have similar Discount Rates and Cash Flow figures. So, the differences in Cash Flow Growth Rates should explain most of the difference in the multiples.

Question 80

What are some of the different ways you calculate Unlevered FCF?

Answer 80

Question 81

When you calculate Unlevered FCF starting with EBIT * (1 – Tax Rate), or NOPAT, you’re
not counting the tax shield from the interest expense. Why? Isn’t that incorrect?

Answer 81

No, it’s correct. If you’re ignoring the company’s capital structure, you have to ignore
EVERYTHING related to its capital structure. You can’t say, “Well, let’s exclude interest… but
let’s still keep the tax benefits from that interest.”

The tax savings from the interest expense do not exist if there is no interest expense.