Equity Value & Enterprise Value REFINED COPY Flashcards
How do you use Equity Value and Enterprise Value differently?
- Equity Value gives you a general idea of how much a company is worth; Enterprise Value tells you more specifically how much it would cost to acquire.
- You use them differently depending on the valuation multiple you’re calculating.
- If the denominator of the multiple includes interest income and expense (e.g. Net Income) you use Equity Value; otherwise if it does not (e.g. EBITDA) you use Enterprise Value
What’s the formula for Enterprise Value?
Simple Formula
Enterprise Value = Equity Value + Debt + Preferred Stock + Non-controlling Interests - Cash
Advanced Formula
Enterprise Value = Equity Value + Debt + Preferred Stock + Non-controlling Interests + Capital Leases + Unfunded Pension Obligations and Other Liabilities - Cash - NOLs - Equity Investments
Equity Value PLUS
- Debt
- Preferred Stock
- Non-controlling Interests
- Capital Leases
- Unfunded Pension Obligations & Other Liabilities
LESS
- Cash
- NOLs
- Equity Investments (Associate Companies)
What’s the difference between Equity Value and Shareholder’s Equity?
- Equity Value is the market value and Shareholder’s Equity is the book value.
- Equity Value could never be negative b/c shares outstanding and share prices can never be negative
- Shareholder’s Equity can be positive‚ negative or zero.
- For healthy companies‚ Equity Value usually far exceeds Shareholder’s Equity b/c the market value of a company’s stock is worth far more than its paper value.
- In some industries (e.g. financial institutions)‚ Equity Value and Shareholder’s Equity tend to be very close.
Should you use Enterprise Value or Equity Value with Net Income when calculating valuation multiples?
Since Net Income includes the impact of interest income and interest expense‚ you always use Equity Value.
Why do you use Enterprise Value for Unlevered Free Cash Flow multiples, but Equity Value for Levered Free Cash Flow multiples? Don’t they both just measure cash flow?
- Unlevered FCF (FCF to firm) excludes interest income and interest expense (and mandatory debt repayments)
- Levered FCF (FCF to equity holders) includes interest income and interest expense (and mandatory debt repayments)
- For Levered FCF only Equity Investors are entitled to that cash flow, therefore‚ you use Equity Value for Levered FCF
• Can you describe a few of the additional items that might be a part of Enterprise Value‚ beyond Cash‚ Debt‚ Preferred Stock‚ and Noncontrolling Interests‚ and explain whether you add or subtract each one?
Items that may be counted as Cash-Like items and subtracted:
- Net Operating Losses (NOLs): b/c you can use these to reduce future taxes; may or may not be true depending on company and deal
- Short-Term and Long-Term Investments: b/c theoretically you can sell these off and get extra cash. May not be true if they’re illiquid.
- Equity Investments: Any investments in other companies where you own between 20-50%; this one is also partially for comparability purposes since revenue and profit from these investments show up in the company’s Net Income‚ but not in EBIT‚ EBITDA‚ and Revenue
Items that may be counted as Debt-Like items and added:
- Capital Leases: Like Debt‚ these have interest payments and may need to be repaid.
- (Some) Operating Leases: sometimes you need to convert Operating Leases to Capital Leases and add them as well‚ if they meet criteria for qualifying as Capital Leases
- Unfunded Pension Obligations: These are usually paid w/ something other than the company’s normal cash flows‚ and they may be extremely large.
- Restructuring/Environmental Liabilities: similar logic to unfunded pension obligations
How do you factor in Convertible Preferred Stock in the Enterprise Value calculation?
• The same way you would factor in normal Convertible Bonds:
if it’s in-the-money‚ you assume that new shares get created‚ and if it’s not in-the-money‚ you count it as Debt.
- 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 Diluted Equity Value?
- The Basic Equity Value is $1000 (100 * $10 = $1000).
- 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‚ 10 new shares get created - the share count is now 110 rather than 100.
- However‚ 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 uses to buy back 5 of the new shares created.
- So the fully diluted share count is 105 and the Diluted Equity Value is $1‚050.
- 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 Diluted Equity Value?
- $1000.
- In this case‚ the options’ exercise price is above the current share price (options are not in-the-money)‚ so they have no dilutive effect.
- A company has 1M shares outstanding at a value of $100 per share.
- It also has $10M of convertible bonds‚ with par value of $1000 and a conversion price of $50.
- How do I calculate diluted shares outstanding?
- First‚ note that these convertible bonds are in-the-money b/c the company’s share price is $100‚ but the conversion price is $50.
- So we count them as additional shares rather than debt.
- Next‚ we need to divide the value of the convertible bonds $10M by the par value $1000 to figure out how many individual bonds there are ($10M / $1000 = 10‚000 convertible bonds).
- Next‚ we need to figure out how many shares this number represents. The number of shares per bond is the par value divided by the conversion price: $1000 / $50 = 20 shares per bond
- So we have 200‚000 new shares (20 * 10‚000) created by the convertibles‚ giving us 1.2M diluted shares outstanding.
- We do not use the Treasury Stock Method with convertibles b/c we do not pay the company anything to “convert” the convertibles
- It just becomes an option automatically once the share price exceeds the conversion price.
- A company has 10‚000 shares outstanding and a current share price of $20.
- It also has 100 options outstanding at an exercise price of $10.
- It also has 50 Restricted Stock Units (RSUs) outstanding
- Finally‚ it also has 100 convertible bonds outstanding‚ at a conversion price of $10 and par value of $100.
- What is its Diluted Equity Value?
- First‚ let’s tackle the options outstanding: since they are in-the-money‚ we assume that they get exercised and that 100 new shares get created.
- The company receives 100 * $10 = $1000 in proceeds. Its share price is $20 so it can repurchase 50 shares with these proceeds. Overall‚ there are 50 additional shares outstanding now (100 new shares - 50 repurchased).
- The 50 RSUs get added as if they were common shares‚ so now there’s a total of 100 additional shares outstanding.
- For the convertible bonds‚ the conversion price of $10 is below the company’s current share price of $20‚ so conversion is allowed.
- We divide the par value by the conversion price to see how many new shares per bond get created: $100 / $10 = 10 new shares per bond
- Since there are 100 convertible bonds outstanding‚ we therefore get 1‚000 new shares (100 convertible bonds * 10 new shares per bond)
- In total‚ there are 1‚100 additional shares outstanding. The diluted share count is therefore 11‚100.
- The Diluted Equity Value is 11‚100 & $20 = $222‚000
This same company from the following question which featured this answer:
“• In total‚ there are 1‚100 additional shares outstanding. The diluted share count is therefore 11‚100.
• The Diluted Equity Value is 11‚100 & $20 = $222‚000”
…also has Cash of $10‚000‚ Debt of $30‚000 and Noncontrolling Interests of $15‚000. What is its Enterprise Value?
• Enterprise Value = Diluted Equity Value - Cash + Debt + Noncontrolling Interest • Enterprise Value = $222K - $10K + $30K + $15K = $257K
