Equity Value, Enterprise Value, Valuation Metrics and Multiples

Question 1

What do Equity Value and Enterprise Value MEAN? Don’t explain how you calculate them – tell me what they mean!

Answer 1

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

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).

EV is the price you have to pay to pay off every stakeholder (i.e. equity and debt holders)

The purpose of calculating TEV is to be able to compare the value / cost of companies with various capital structures (varying levels of cash and debt).

Consider a company, Company X, with $50 in debt and $20 in cash. Let’s say that you buy the company for $200 total (i.e., $200 is the equity value, also known as the market cap of the company). When you acquire company X, you assume the liability of owing its debtholders $50, and you also get to keep the $20 in cash that Company X has on its balance sheet. As such, if you (hypothetically) were to pay down the debt and draw out the cash at the time that you bought the company, the following would occur:

Pay $200 to acquire Company X
Pay $50 to pay off Company X’s debtholders (often times, this type of thing can be triggered by a change in control of Company X)
Receive $20 from Company X (I’m making a simplifying assumption that Company X doesn’t need any cash on hand to run its business)

As such, you’ll have effectively paid $230 (equity value of $200 + $50 of debt - $20 of cash) for the company.

All in all, if you had two companies – Company X and Company Y – that had the same equity value of $200, you’d want to know the enterprise value to be able to compare which company is a better deal (the one with less net debt).

Question 2

Why do you use both Equity Value and Enterprise Value? Isn’t Enterprise Value more accurate?

Answer 2

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 3

Why do you pair Net Assets with Common Shareholders in Equity Value, but Net Operating Assets with All Investors in Enterprise Value? Isn’t that an arbitrary pairing?

Answer 3

No. The logic is that Common Shareholders’ Equity can be generated internally (via Net Income) or raised externally (Stock Issuances), so the company can use it for both Operating and NonOperating Assets.

But if the company raises funds via outside investors (Debt, Preferred Stock, etc.), then most likely it will use those funds to pay for Operating Assets, rather than spending the money on random Non-Operating Assets (such as a whiskey side business for a software company). This rule does not always hold up in real life, but this is the basic rationale

Question 4

What’s the difference between Current Enterprise Value and Implied Enterprise Value?

How do you calculate current EV?

Answer 4

Current Enterprise Value is what “the market as a whole” thinks the company’s core business operations are worth to all investors; Implied Enterprise Value is what you think the corebusiness operations are worth based on your views and analysis.

You calculate Current Enterprise Value for public companies by starting with Current Equity Value, subtracting Non-Operating Assets, and adding Liability and Equity line items that represent other investor groups (i.e., ones beyond the common shareholders).

Equity to EV bridge:

Current Share Price
(x) Shares Outstanding
= Equity Value

Equity Value
(-) Cash & Cash Equivalents
(-) Financial Investments (i.e. stocks, bonds)
(-) Equity Investments (i.e. minority investments)
(+) Debt (i.e. LT debt, Capital Leases)
(+) Preferred Stock
(+) Non-controlling Interest
= Enterprise Value

But you calculate Implied Enterprise Value based on valuation methodologies such as the Discounted Cash Flow (DCF) analysis, comparable public companies, and precedent
transactions.

Question 5

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

Answer 5

Remember that Company Value = Cash Flow / (Discount Rate – Cash Flow Growth Rate), where Cash Flow Growth Rate < Discount Rate.

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.

In most cases, your view of a company’s value will be different than the market’s view because you believe its cash flow will grow at a faster or slower rate.

Question 6

Why do you subtract Cash, add Debt, and add Preferred Stock when moving from Equity
Value to Enterprise Value in the “bridge”?

Answer 6

You subtract Non-Operating Assets because Enterprise Value reflects only Net Operating
Assets. Cash and Investments are examples of Non-Operating Assets, but Equity Investments (Associate Companies), Assets Held for Sale, and Assets Associated with Discontinued Operations also count.

You add Liability & Equity line items that represent other investor groups beyond the common shareholders because Enterprise Value represents All Investors. Debt and Preferred Stock are the most common examples, but Underfunded Pensions, Capital Leases, and Noncontrolling Interests also qualify.

You’re looking to calculate the VALUE of a company through EV. In broad terms, value of a company is assumed to be the present vale of its future cash flows. The excess cash on the books (not all cash is excess cash) is assumed to be a non-operating asset. It does not aid in generation of future cash flows and therefore does not contribute to value. That is why it is subtracted.

Question 7

You’re about to buy a house using a $600K mortgage and a $200K down payment. What
are the real-world analogies for Equity Value and Enterprise Value in this case?

Answer 7

The “Enterprise Value” here is the $800K total price of the house, and the “Equity Value” is the $200K down payment you’re making.

Equity value “available to all equity / common shareholders” - what you have access to as the owner of the property (the equity in the house)

Debt = $600K - mortgage to the bank (not available to equity shareholders, but available to other investors (i.e. debt, preferred, etc.)

Question 8

Could a company’s Equity Value ever be negative?

Answer 8

Trick question. A company’s Current Equity Value cannot be negative because it is based on Shares Outstanding * Current Share Price, and neither of those can be negative. It also can’t be negative for private companies.

However, its Implied Equity Value could be negative because you use your views and
assumptions to calculate that. If the company’s Implied Enterprise Value is $0, for example, and it has more Debt than Cash, then its Implied Equity Value will be negative.
Note, however, that you typically say its Equity Value is $0 in cases like this (and assume the company is worthless).

EV
(-) debt
(+) cash
= Equity value

Question 9

Could a company’s Enterprise Value ever be negative?

Answer 9

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.

Equity Value
(-) cash
(+) debt
= Enterprise Value

Once again, you often say the company’s Enterprise Value is simply $0 in cases like this.

Question 10

How do events impact Equity Value and Enterprise Value?

Answer 10

These questions always refer to current equity value and and current enterprise value so only think about changes to the company’s B/S and not its future cash flows

1) Does Common Shareholders’ Equity (CSE) change?
- if so then Equity Value changes by the same amount that CSE changes (if not then Equity Value does not change)
- Usually could think of “does net assets change”? (be careful if there are noncontrolling interests or preferred stock as net assets no longer equal CSE!)

2) Do Net Operating Assets (NOA) change?
- if so then Enterprise Value changes by the same amount that NOA changes (if not then Enterprise Value does not change)
- NOA examples: PP&E increases, inventory increases, A/R decreases, Deferred revenue increases, GOODWILL
- Financing events do NOT affect Enterprise Value (some nuances in practice due to WACC / discount rate likely being sensitive to how much financing / debt is taken on)
- Financing event examples: Issuing debt, repaying debt, issuing stock, repurchasing shares, issuing dividends
- In the above examples, NOA does not change (cash, debt, and common stock are all non-operating in nature)

Question 11

Why do financing events such as paying Dividends or issuing Debt not affect Current Enterprise Value?

Answer 11

Current Enterprise Value changes only if Net Operating Assets change.

Paying Dividends reduces the company’s Cash and Common Shareholders’ Equity, and issuing Debt increases the company’s Cash and Debt. None of these is an Operating Asset or Liability, so Current Enterprise Value cannot possibly change.

Question 12

You estimate a company’s Implied Value with Company Value = Cash Flow / (Discount
Rate – Cash Flow Growth Rate), where Cash Flow Growth Rate < Discount Rate.
Will this give you the company’s Implied Equity Value or Implied Enterprise Value?

Answer 12

It depends on the type of Cash Flow and the Discount Rate you are using. If you’re using Cash Flow Available to All Investors (i.e., Unlevered FCF or Free Cash Flow to Firm) and WACC for the Discount Rate, then this formula will produce the Implied Enterprise Value.

If you’re using Cash Flow Available ONLY to Equity Investors (i.e., Levered FCF or Free Cash Flow to Equity) and Cost of Equity for the Discount Rate, then this formula will produce the Implied Equity Value.

Question 13

If financing events do not affect Current Enterprise Value, what DOES affect it?

Answer 13

Only changes to the company’s Net Operating Assets (i.e., changes to its “core business”) affect Enterprise Value.
For example, if the company purchases PP&E using Cash, or it raises Debt to purchase PP&E or Inventory, both of those will increase Current Enterprise Value.

Question 14

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

Answer 14

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

So, for example, 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 15

In theory, if Companies A and B are the same in all respects, but Company A is financed
with 100% Equity, and Company B is financed with 50% Equity and 50% Debt, will their
Enterprise Values will be the same?

Answer 15

Yes b/c enterprise value is capital structure neutral / not effected by different capital structures

However, in reality:

Because a company’s capital structure, whether current, optimal, or targeted, affects the
Discount Rate used to calculate the Implied Enterprise Value (and the Discount Rate “the
market as a whole” uses for the company’s Current Enterprise Value).

Not only do the percentages of Equity, Debt, and Preferred Stock affect WACC, but the Cost of each one also changes as the company’s capital structure changes.

For example, going from no Debt to a small amount of Debt may initially reduce WACC because Debt is cheaper than Equity. But past a certain point, additional Debt will increase WACC because the risk to all investors starts increasing at that stage.

Enterprise Value is LESS affected by capital structure changes than Equity Value, but there will still be some effect.

Question 16

A company issues $200 in Common Shares. How do Equity Value and Enterprise Value
change?

Answer 16

CSE increases by $200, so Eq Val increases by $200.

NOA does not change because neither Cash nor CSE is operational, so TEV stays the same.

Alternatively, in the TEV formula, the extra Cash offsets the higher Equity Value.

Question 17

A company issues $200 in Common Shares, and it uses $100 from the proceeds to pay Dividends to the common shareholders. How do Equity Value and Enterprise Value
change?

Answer 17

CSE increases by $100 after both changes, so Eq Val increases by $100.

NOA does not change because neither Cash nor CSE is operational, so TEV stays the same.

Alternatively, in the TEV formula, the extra Cash offsets the higher Equity Value.

Question 18

A company issues $200 in Common Shares, and decides to use the $200 in proceeds from new Common Stock to acquire another business for $100. How do Equity Value and Enterprise Value change?

Answer 18

CSE increases by $200 from this issuance, so Eq Val increases by $200.

Of this $200 in proceeds, $100 remains in Cash, and $100 is allocated to Acquired Assets from the other business.

These Acquired Assets are Operating Assets, and no Operating Liabilities change, so NOA increases by $100. TEV, therefore, increases by $100.

Question 19

A company issues $200 in Common Shares, and decides to use the $200 in proceeds from new Common Stock to acquire an asset for $100. How do Equity Value and Enterprise Value change?

Answer 19

CSE still increases by $200, so Eq Val is up by $200.

If this Asset is considered “Operating” or “Core,” such as a factory, then NOA increases by $100, so TEV also increases by $100.
If not – for example, the Asset is a short-term investment – then NOA does not change, and TEV stays the same.

Question 20

What happens if this company issues $200 in Debt to fund a $100 Asset acquisition
instead?

Answer 20

The main difference is that Eq Val no longer changes because CSE does not change as a result of a Debt issuance.

If this $100 Asset is Operational, NOA increases, so TEV increases by $100; if not, TEV stays the same.

Question 21

A company issues $200 of Debt to fund a $200 Equity Purchase Price acquisition of a
company with $150 in Common Shareholders’ Equity.
How do Equity Value and Enterprise Value change, considering that the acquirer must create Goodwill?

Answer 21

The $50 of Goodwill here does not affect anything because Goodwill is an Operating Asset.

$200 of Acquired Company Assets vs. $150 of Acquired Company Assets and $50 of Goodwill make the same impact on both Eq Val and TEV.

This $200 Debt Issuance does not affect CSE, so Eq Val stays the same.

TEV increases by $200 because NOA increases by $200 (Operating Assets increase by $200, and no Operating Liabilities change).

Question 22

A company issues $100 in Preferred Stock to purchase $50 of PP&E. How do Equity Value and Enterprise Value change?

Answer 22

CSE does not change because Preferred Stock issuances flow into Preferred Stock within Equity, not Common Shareholders’ Equity. Therefore, Eq Val stays the same.
NOA increases by $50 because the PP&E is an Operating Asset, and no Operating Liabilities change, so TEV increases by $50.

Question 23

Now the company issues $100 in Preferred Stock to repurchase $50 of Common Stock. How do Equity Value and Enterprise Value change?

Answer 23

CSE decreases by $50 because of this repurchase, so Eq Val decreases by $50.

NOA does not change because Cash, Preferred Stock, and CSE are all Non-Operating, so TEV stays the same.

Question 24

A company issues $150 of Debt and $50 of Common Stock to acquire $175 of PP&E and $25 of Short-Term Investments. How do Equity Value and Enterprise Value change?

Answer 24

CSE increases by $50 because of the Common Stock Issuance, so Eq Val increases by $50.

The $175 of PP&E counts as an Operating Asset, and no Operating Liabilities change (Debt is Non-Operating), so NOA increases by $175, and TEV also increases by $175.

Question 25

Current Equity Value represents the Market Value of ALL Assets.

But if that’s the case, why doesn’t a $100 Debt issuance boost Equity Value? The company receives $100 in extra Cash from this issuance, which should boost its Total Assets.

Answer 25

This is a trick question because the interviewer makes two mistakes in the premise:

1) Equity Value represents Net Assets, not Total Assets.

2) And Current Equity Value represents the Net Assets’ market value only to Equity
Investors.

So, Eq Val does not change in this scenario because Common Shareholders’ Equity does not change, so nothing related to point #2 changes. And Net Assets doesn’t even change, going along with point #1.

Question 26

A company purchases $100 of Inventory using Cash. How do Equity Value and Enterprise Value change?

Answer 26

There are no changes on the Income Statement in this initial step because the Inventory has not
yet been sold.

On the Balance Sheet, CSE stays the same in this initial step, so Eq Val stays the same.

NOA increases by $100 since Inventory is an Operating Asset, and no Operating Liabilities
change, so TEV increases by $100.

Question 27

A company purchases $100 of Inventory using Cash

Now assume the Inventory is sold for $200 and walk me through how the entire
process from beginning to end affects Equity Value and Enterprise Value.

Answer 27

On the Income Statement, Revenue is up by $200, and Pre-Tax Income is up by $100 (due to the $100 of Inventory now being recognized as COGS). Net Income increases by $75 at a 25% tax rate.

On the CFS, Net Income is up by $75, and there are no other changes (Inventory went up and
now goes down), so Cash is up by $75 at the bottom.

On the Balance Sheet, Cash is up by $75 on the Assets side, and CSE is up by $75 on the L&E
side.

Since CSE is up by $75, Eq Val increases by $75.

NOA does not change because Cash is not an Operating Asset and no Operating Liabilities
change, so TEV stays the same.

Intuition: This 2-step process represents the company generating Net Income and letting it sit in
cash; that process does not make its core business more valuable, so TEV does not increase.

Question 28

A company collects $200 of cash from a customer upfront for a service that it has not yet delivered. How do Equity Value and Enterprise Value change?

Answer 28

This change is recorded as a $200 increase in Cash on the Assets side of the Balance Sheet, and
a $200 increase in Deferred Revenue on the L&E side.

CSE does not change because there’s no Net Income generation yet, and there are no
Dividends, Stock Issuances, or Stock Repurchases, so Eq Val stays the same.

NOA decreases by $200 because the Deferred Revenue is an Operating Liability, and no
Operating Assets change. Therefore, TEV decreases by $200.

Question 29

A company collects $200 of cash from a customer upfront for a service that it has not yet delivered.

Now, the company delivers the service to the customer and recognizes the $200 as
Revenue, along with $100 in Operating Expenses. Walk me through how the entire process
from beginning to end affects Equity Value and Enterprise Value.

Answer 29

On the IS, Pre-Tax Income is up by $100, and Net Income is up by $75 at a 25% tax rate. On the CFS, Net Income is up by $75, and nothing else changes (DR went up and now goes down), so Cash is up by $75.

On the BS, Cash is up by $75 on the Assets side, and CSE is up by $75 on the L&E side. Since CSE is up by $75, Eq Val increases by $75.

NOA does not change because Cash is Non-Operating, and no Operational Liabilities have had a cumulative change, so TEV stays the same.

Intuition: This 2-step process represents the company generating Net Income and letting it sit in Cash; that process does not make its core business more valuable, so TEV does not increase

Question 30

A CEO finds $100 of Cash on the street and adds it to the company’s bank account. How do Equity Value and Enterprise Value change?

Answer 30

This event would be recorded as a $100 Extraordinary Gain on the Income Statement.

If you ignore Taxes completely, Net Income increases by $100, Cash increases by $100, and on the Balance Sheet, Cash is up by $100 on the Assets side, and CSE is up by $100 on the L&E side.

CSE is up by $100, so Eq Val increases by $100.

NOA does not change because no Operating Assets or Liabilities change, so TEV stays the same.
If you factor in Taxes and assume a 25% rate, Net Income and Cash increase by $75 instead, so Eq Val increases by $75, and TEV remains the same.

TEV would change only if you assumed that the Extraordinary Gain does not affect Cash Taxes, in which case the DTA would decrease by $25, reducing TEV by $25 (we don’t recommend mentioning this in interviews because it’s more advanced and will lead to harder questions).

Intuition: “Finding” a Non-Operating Asset on the street does not make a company’s core business more valuable.

Question 31

A company experiences a disaster at one of its factories and records a $100 PP&E WriteDown. It also decides to issue $50 in Common Stock to get the funds required to replace this factory in the future. How do Equity Value and Enterprise Value change?

Answer 31

The PP&E Write-Down reduces Pre-Tax Income by $100 and Net Income by $75 at a 25% tax
rate.

On the CFS, Net Income is down by $75, but the Write-Down is non-cash, so you add back $100.

You also reflect the $50 Stock Issuance in CFF, so Cash at the bottom increases by $75.

(We’re ignoring Cash vs. Book Taxes in this question and assuming the Write-Down is deductible
for both, for simplicity.)

On the BS, Cash is up by $75, and Net PP&E is down by $100, so the Assets side is down by $25.

The L&E side is also down by $25 due to the $75 Net Income reduction and $50 Stock Issuance.
CSE is down by $25, so Eq Val is down by $25.

NOA is down by $100 due to the $100 PP&E Write-Down, and no Operating Liabilities change,
so TEV decreases by $100.

Intuition: Changes to Operational line items can affect both TEV and Eq Val, but the impact on
Eq Val may be “reduced” if the company also changes its capital structure at the same time.

Question 32

A company has excess Cash. How do Equity Value and Enterprise Value change if the
company uses the Cash to repay Debt vs. repurchase Common Stock?

Answer 32

NOA does not change in any case because nothing here is operational, so TEV stays the same.

In the first case – Debt repayment – CSE does not change because Debt issuances and
repayments do not affect it, so Eq Val does not change.

In the second case – a Common Stock repurchase – CSE decreases, so Eq Val decreases

Question 33

A company issues a press release indicating that it expects its revenue to grow at 20% rather than its previous estimate of 10%. How does everything change?

Answer 33

This change relates more to the company’s Implied or Intrinsic value. Since the company expects higher sales growth, both its Implied Enterprise Value and Implied Equity Value will increase
because they are both based on the company’s expected future cash flows.

Current Eq Val and Current TEV may also increase if the company’s share price instantly jumps up, but you can’t link the change to one specific line item on the Balance Sheet changing; there won’t be an immediate change on the BS right after this announcement.

Question 34

What IS a valuation multiple?

Answer 34

A valuation multiple is shorthand for a company’s value based on its Cash Flow, Cash Flow Growth Rate, and Discount Rate. You could value a company with this formula:
Company Value = Cash Flow / (Discount Rate – Cash Flow Growth Rate), where Cash Flow Growth Rate < Discount Rate

But instead of providing all that information, valuation multiples let you use a number like “10x” and express it in a condensed way.

You can also think of valuation multiples as “per-square-foot” or “per-square-meter” values when buying a house: they help you compare houses or companies of different sizes and see how expensive or cheap they are, relative to similar houses or companies.