Enterprise/Equity Value Questions - Basic

Question 1

1. Why do we look at both Enterprise Value and Equity Value?

Answer 1

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 2

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

Answer 2

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

Question 3

3. What’s the formula for Enterprise Value?

Answer 3

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

Question 4

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

Answer 4

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 5

5. How do you calculate fully diluted shares?

Answer 5

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 the dilutive effect of options, you use the Treasury Stock Method (detail on this below).

Question 6

6. 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?

Answer 6

Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all “in-the-money” – their exercise price is less than the current share price.
When these options are exercised, there will be 10 new shares created – so the share count is now 110 rather than 100.

However, that doesn’t tell the whole story. In order to exercise the options, we had to “pay” the company $5 for each option (the exercise price).

As a result, it now has $50 in additional cash, which it now uses to buy back 5 of the new shares we created.

So the fully diluted share count is 105, and the fully diluted equity value is $1,050.

Question 7

7. 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?

Answer 7

$1,000. In this case the options’ exercise price is above the current share price, so they have no dilutive effect.

Question 8

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

Answer 8

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.