Enterprise / Equity Value Questions 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 types of investors. Equity Value only represents the portion available to shareholders, equity investors. You would look at both because Equity Value represents what the public sees at large, while Enterprise Value represents the company’s true value.
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.
What’s the formula for Enterprise Value?
EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash
Why do you need to add Minority Interest to Enterprise Value?
If a company owns more than 50% of another company, it is required to report the full financial performance of that subsidiary as part of its own. This is why minority interest is added to Enterprise Value – to reflect the value of 100% of the majority-owned subsidiary, even though the parent company doesn’t own all of it.
How do you calculate fully diluted shares?
Start with the basic share count and add the dilutive effect of stock options and other dilutive securities, such as warrants, convertible debt, or convertible preferred stock. When calculating the dilutive effect of options, use the Treasury Stock Method.
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 $5 each – what is its fully diluted equity value?
The basic equity value is $1,000, since 100 shares outstanding at $10 each equals $1,000. To calculate the dilutive effect of the options, you have to first note that they’re all in-the-money, meaning their exercise price is less than the current price. When they’re exercised, there’ll be 10 new shares created, resulting in 110 total shares rather than 100. However, when the options are exercised, the company gets $5 for each, resulting in $50 of additional cash. This $50 can be used to buy back 5 of the new shares that were created, resulting in a diluted share count of 105, and a fully diluted equity value of $1,050.
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 its fully diluted equity value?
$1,000. Since the options’ exercise price is above the current share price, they have no dilutive effect.
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.
Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?
You would add debt in most cases. Enterprise Value represents the total value of the company, including both its assets and liabilities. The terms of most debt agreements also state that the debt has to be refinanced in an acquisition (change-of-control provisions). However, there are always exceptions. It’s rare for a company not to pay off a seller’s debt, but it’s still possible.
Could a company have a negative Enterprise Value? What would that mean?
Yes, absolutely. A company can have a negative Enterprise Value if it has an exceptionally large cash balance relative to its market capitalization and debt, or if it has too much debt compared to its equity value. It is often seen with distressed companies or financial institutions, such as banks, that have large cash balances.
Could a company have a negative Equity Value? What would that mean?
No. This is not possible because you cannot have a negative share count and you cannot have a negative share price.
Why do we add Preferred Stock to get to Enterprise Value?
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.
How do you account for convertible bonds in the Enterprise Value formula?
If the convertible bonds are in-the-money, meaning their conversion price is lower than the share price, you count them as additional dilution to the Equity Value. If they are out-of-the-money, you count the face value as part of the company’s 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 $1,000 and a conversion price of $50. How do I calculate diluted shares outstanding?
Since the conversion price is lower than the share price, the convertible bonds are in-the-money, so you count them as additional shares instead of debt. Next, find out how many individual bonds there are by dividing the value of the convertible bonds by the par value, which would give you 10,000 convertible bonds. Then, determine how many shares each bond represents. You do this by dividing the par value by the conversion price, which gets you 20 shares per bond. So, we have 200,000 new shares created by the convertibles, giving us 1.2 million diluted shares outstanding.
What’s the difference between Equity Value and Shareholders’ Equity?
Although Equity Value and Shareholders’ Equity may seem similar, they are distinct. Equity Value is the market’s perception of a company’s worth and can never be negative because share prices and shares outstanding are always positive. In contrast, Shareholders’ Equity is the company’s book value and can be any value, positive or negative. For healthy companies, Equity Value typically far exceeds Shareholders’ Equity.
