Enterprise/Equity Value Basic Flashcards
Why do we look at both enterprise value and equity value?
Enterprise value represents the value of the company that is attributable to all investors
It is the total value of companies operations, equity, and debt
Equity value only represents the portion available to shareholders equity investors value of companies equity
You look at both because equity value is the number the public at large seas. All enterprise value represents its true value.
Equity value helps shape future decisions. It is also considered market capitalization or the total value of common and preferred shares. It is the total dollar market value the current share price times number of shares outstanding
When looking at an acquisition of a company, do you pay more attention to enterprise or equity value?
Enterprise value because that’s how much an acquirer really pays and includes the often mandatory debt repayment, equity, and debt
What’s the formula for enterprise value?
EV = equity value + debt + preferred stock + non-controlling interest -cash
Preferred stock is a hybrid instrument where dividends are paid first
This formula does not tell the whole story and can get more complex
Noncontrolling interest, formally known as minority interest
Shareholder owns less than 50% controlling interest is where shareholders have voting rights
Direct receives a proportionate allocation pre-and post acquisition, recorded equity of a subsidiary owned or controlled by another company
Indirect post acquisition amounts only
Why do you need to add the noncontrolling interest to EV?
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.
EV acts like a price tag
So even though it doesn’t own 100% it reports 100% of the majority own subsidiaries financial performance
In keeping with the apples to apples theme, you must add the noncontrolling interest to get to EV so that your numerator and denominator both reflect 100% of the majority owned subsidiary
Noncontrolling interest is part of the company not owned by the parent company
How do you calculate fully diluted shares?
Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities such as warrants, convertible, debt or convertible preferred stock
To calculate dilutive effect of options, use the treasury stock method
Dilutive securities are securities that can be converted into common stock
Stock options, companies allow employees, contracts, investors to purchase a specific number of shares at a price
Add all potentially dilutive securities to current number of shares outstanding
Let’s say a company has 100 shares outstanding at a share price of $10 each. It also has 10 options outstanding at an exercise price five dollars each. What is it fully diluted equity value or market capitalization?
Treasury stock method
So you’re basic equity value is $1000 because it’s 100×10 which equals 1000
Next to calculate the dilutive effect of the options first, you note the options are all in the money. Their exercise price is less than the current share price therefore will be profitable.
When these options are there will be 10 new shares created so the share account is now 110 rather than 100
That does not tell the whole story in order to exercise the options we had to pay the five dollars each for each option exercise price
As a result, it now has $50 in additional cash which it now uses to buy back five of the new shares we created. This is more of an assumption rather than a transaction that the proceeds received from options. Option holders are used to re-purchase shares in the market.
So the fully diluted share count is 105 and fully diluted equity value is 1050
In the money option is considered in the money if it if it could lead to monetary gain based on the current price of the asset, you wanna buy shares at an exercise price than sell at market price for a profit
EPS = NI - PD/WACS
NI net income
PD preferred dividend
WASO Shares outstanding
Dilutive effect refers to decrease in EPS, but an increase in shares outstanding
out of the money means not profitable
Call Option is the right to buy an asset higher than strike price or buy price
Put Option right to sell asset current market price is lower than strike price
Neutral impact increase in equity exercising options, decreasing equity repurchasing shares
Let’s say a company has 100 shares outstanding at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each. What is it fully diluted equity value?
$1000 in this case the options exercise price is above the current share price so they have no dilutive effect
Out of the money, not profitable no dilutive effect
Dilution, relation and ownership percentage of a company shareholders when the company issues new shares
Why do you subtract cash in the formula for enterprise value? Is that always accurate?
Cash is subtracted because it’s considered a non-operating asset and because equity value implicitly accounts for it.
Think of buying a house, but the house has a bag of cash inside this technically reduces the amount you paid.
In an acquisition, the buyer would get the cash of the seller so it effectively pays less for the company based on how large it’s cash balance is enterprise values all about how much you pay for a company.
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 requires to operate.
When a company is acquired, the acquiring company would get any excess cash effectively reducing the purchase price.
Is it always accurate to add debt to equity value when calculating enterprise value?
In most cases, yes, because the terms of a debt agreement usually say that debt must be refinanced in an acquisition.
In most cases, a buyer will pay off a sellers debt, so it is accurate to say that any debt adds to the purchase price.
However, there could be exceptions where the buyer does not pay off the debt very rare, but never say never.
Enterprise value meant to represent entire value of a company, including the value attributable to both equity and debt holders other factors need to be taken into account.
Could a company have a negative enterprise value? What would that mean?
Yes, it is possible. It could mean a company has extremely low market cap or giant cash balance.
Means the company has an extremely large cash balance or an extremely low market capitalization or both.
You see it with companies on the brink of bankruptcy financial institution, such as banks that have large cash balances, but enterprise value is not even used for commercial banks doesn’t matter as much.
Could a company have a negative equity value? What does that mean?
No, not possible you can’t have a negative share count. You can’t have a negative share price.
Why do we add preferred stock to get to enterprise value?
Preferred stock pays out a fixed dividend and stockholders also have a higher claim to a company’s assets than equity investors do.
More similar to debt than common stock pays fixed dividend debt pays, fixed interest.
Preferred stock higher claims not in normal equity basket represents a claim on companies assets and earnings in an acquisition. Preferred stock usually needs to be repaid.
How do you account for convertible bonds in the enterprise value formula?
If the bonds are in the money, meaning the conversion price of the bond is below the current share price then you count them as additional dilution to the equity value
If out of the money, then you count the face value of the convertible bonds as part of the companies debt.
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 $1000 and a conversion price of $50. How do I calculate diluted shares outstanding?
In the money because share price is $100 and conversion price is $50 so count as additional shares rather than debt.
Value of convertible bonds/par value see how many individual bonds we get.
10,000,000/1000 = 10,000 convertible bonds
Next figure out how many shares this number represents
Par value/conversion price
1000/50 = 20 shares per bond
So 200,000 new shares
1.2 million diluted shares outstanding
Don’t use treasury stock method with convertibles because the company is not receiving any cash from this.
What’s the difference between equity value and shareholders equity?
Equity value is the market value big picture never negative reflects fluctuations
Shareholders equity is the book value reflects fluctuations as gains and losses you can have negative retained earnings negative shareholders equity
Equity value can never be negative because shares outstanding and share prices can never be negative
Shareholders equity can be any value
Healthy companies equity value usually exceeds shareholders equity
