EqV & EV + Multiples

Question 1

What do Equity Value and Enterprise Value MEAN?

Answer 1

• EqV: value of EVERYTHING the company has, but only to common equity investors (shareholders)
• EV: value of core business operations to all investors in the company (equity, debt, preferred, etc)

Question 2

Why look at both of them? Isn’t EV always more accurate?

Answer 2

• Neither one is better or more accurate - they represent different concepts and they are important to different types of investors.
• EV and EV-based multiples have some advantages because they are not affected by changes in the company’s capital structure as much as EqV and EqV-based multiples

Question 3

Difference between Current EV and Implied EV

Answer 3

• Current: is a what the market as a whole think’s the company’s core business operations are worth
• Implied: what you think it’s worth based on your views and analysis

Question 4

Why might a company’s current EV be different from its implied EV?

Answer 4

Originates from a disagreement on company’s growth, margins, and sometimes discount rate

Question 5

Everyone knows how to move from EqV to EV, but WHY do you subtract Cash, add Debt, and Preferred Stock?

Answer 5

EV is value of core business operations to all investors. Cash is a non-core business asset; thus, it is subtracted Debt and Preferred Stock represent two investor groups beyond common equity shareholders

Question 6

You buy a house using $750K mortgage and a $200K down payment. What is real-world EqV and EV?

Answer 6

EV: 750 + 200 = 950

Question 7

Can a company’s EqV be negative?

Answer 7

Current: NO share price is always non-negative and number of shares is non-negtaive => non-negative current EqV Implied EqV: YES due to analyst’s assumptions to calculate that EqV

Question 8

Can a company’s EV be negative?

Answer 8

Current and Implied: YES - for example, a company might have more cash than its market cap and no debt. And perhands implied EV is the same as, or very close to, its current EV

Question 9

Why do financing-related events such as issuing Dividends or raising Debt not affect Enterprise value?

Answer 9

EV represents the value of core business operations to ALL investors; thus, if something does not affect the company’s core business, it won’t affect EV

Question 10

What impacts/affects EV?

Answer 10

Core business operations changes: -new customer contract -higher growth/sales -closes a factory DOES NOT AFFECT: -raising debt, equity -repurchasing stock -issuing dividends

Question 11

Why does EV not necessarily represent the “true cost” to acquire a company?

Answer 11

1. The buyer may not have to repay the seller’s debt (in 99% of the cases they do) 2. buyer may not “get” the seller’s entire cash balance. The seller needs a certain minimum amount of cash to continue operating 3. Buyer has to pay additional fees for M&A advisory, accounting, legal services, and financing

Question 12

If company 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, their enterprise values will be the same. WHY IS THIS NOT TRUE IN REALITY?

Answer 12

Company’s capital structure impacts the discount rate you use to calculate the implied EV

Question 13

A company issues $200 million in new shares. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 13

=> cash+, common shares+ EqV +200 EV +0, Cash -200 EqV +200 = +0 P/E = marketcap or EqV / Net Earnings => P/E increases EV multiples stay the same

Question 14

Company issues $200 million in shares, but will use $100 million form proceeds to issue Dividends. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 14

EqV = +200 -100 = +100 EV = +0 P/E increases EV multiples stay same

Question 15

Company issues $200 million in shares, and uses $100 to acquire another business. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 15

Eqv = +200 (reference guide if forgot how to get this) EV = +100 (since other business is core operational item) All multiples increase

Question 16

Company issues $200 in shares, and uses $100 to acquire an Asset. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 16

Non-core business asset: EqV= +200 EV=+0 P/E increases, others stay same Purchases Core business asset: EqV=+200 EV = +100 All multiples increase

Question 17

Company raises $200 million in Debt to acquire a company for $100. How do EqV, EV, EV / EBITDA, and P / E change? How about if they issue $100 million worth of dividends?

Answer 17

Issuance of debt: EqV = +0 EV= 0 Purchase of business: EqV = EV = +100 Dividend issuance: EqV = -100 (P/E decreases) EV = 0

Question 18

Company raises $200 in debt to acquire another company for $200. The other company’s Common Shareholders’ Equity is 200. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 18

Debt issuance: no change Purchase of business: EqV = +0 EV = +200

Question 19

Company raises $200 in debt to acquire another company for $200. The other company’s Common Shareholders’ Equity is 100. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 19

Acquirer records +100 goodwill (which is still a core asset) Thus, answer is the same EqV = +0 EV = +200

Question 20

Company raises $200 in debt to issue $100 in dividends. How do EqV, EV, EV / EBITDA, and P / E change?

Answer 20

EqV = -100 => P/E falls EV = +0

Question 21

Company has current equity value (market cap) of $200, $50 in cash, and 100 in debt. If the company spends $25 of its cash balance to purchase PP&E, how do EqV, EV, EV / EBITDA, and P / E change?

Answer 21

EqV = +0, cash and PP&E are the same - just assets - in the perspective of equity value EV = +25 because the company has converted $25 non-core assets into core

Question 22

Company has excess cash. What are the valuation implications if it uses that cash to repurchase shares vs repay debt?

Answer 22

EV won’t change for either one. But EqV will! Repurchasing shares: EqV: -X since cash and equity decrease Repay debt: EqV = +0

Question 23

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

Answer 23

EqV = +100 EV = +0

Question 24

Company issues press release indicating it expects its revenue to grow at 20% rather than its previous estimate of 10%. How does EV and EqV change?

Answer 24

Both EV and EqV increase, this is a positive difference in the company’s core business

Question 25

When there’s an operational charge, how can you determine whether Equity Value or EV will change more?

Answer 25

Generally, EV will change more because it is affected ONLY by these operational changes. Since EqV is affected by both financial and operational changes, operational changes tend to make less of an impact. (since they get diluted by financial changes)

Question 26

Will operational changes impact a company’s Current or Implied EV by more?

Answer 26

Operational changes tend to impact a company’s Implied EV by more because you can immediately reflect your views by revising your analysis and calculations ALSO, it sometimes takes time for the market to reflect these operational changes fully, and so current EV takes more time to change

Question 27

If EqV represents the value of all assets. Why doesn’t a debt issuance boost Equity Value?

Answer 27

EqV is value of all assets TO SHAREHOLDERS or equity investors, which explains why EqV doesn’t increase when debt increases.

Question 28

A company trades at a valuation multiple of 13x EV/EBITDA. What does that mean?

Answer 28

It tells us that the company’s EV is 13x its EBITDA. But this is useless by itself, we need comparable companies to compare or relate this multiple to, in order to understand its implications

Question 29

Suppose you graph the EV/EBITDA multiples for a set of similar companies along with the revenue growth rates, EBITDA margins, and EBITDA growth rates. Which operational metric will most likely have the strongest correlation with the EV/EBITDA multiples?

Answer 29

Since a company’s value depends on its cash flow, cash flow growth rate, and Discount Rate, the EV/EBITDA multiples are most likely to be correlated with the EBITDA growth rates. DESPITE this principle, valuation multiples and growth rates often don’t display as much correlation as you might expect.

Question 30

Would you rather buy a company trading at a 15x EV / EBITDA multiple, or one trading at a 10x multiple?

Answer 30

It’s completely dependent on what peer companies are trading at and how this company compares. If every company is trading at 25x then 15 is cheap, for example.

Question 31

Could a valuation multiple such as P / E or EV / EBITDA ever be negative? What would it mean?

Answer 31

Yes, it’s possible for any valuation multiple to be negative (except ones based on revenue) It means that a metric like Net Income or EBITDA is negative. Whichever multiple is negative is not useful for valuing the company

Question 32

If a company has both debt and preferred stock, why is it not valid to use net income rather than net income to common when calculating P/E

Answer 32

You shouldn’t use half-pregnant multiples which market cap to net income would be in this case.

Question 33

If a company’s cash flow matters most, why do you use metrics like EBIT and EBITDA in valuation multiples rather than CFO or FCF?

Answer 33

-Convenience and comparability Different companies report slightly different things under CFO and FCF can vary among companies widely

Question 34

Advantages and disadvantages of EV / EBITDA vs. EV / EBIT vs. P / E?

Answer 34

Never look at just one multiple when valuing companies! Valuation is about big picture. EV / EBITDA vs. EV / EBIT EV / EBITDA is better in cases when you want to completely exclude the company’s CapEx, Depreciation, and capital structure EV / EBIT is better when you want to exclude capital structure, but partially factor in CapEx and Depreciation. It is common in industries, such as manufacturing, where those items are key value drivers for companies. The P / E multiple is not terribly useful in most cases because it’s affected by different tax rates, capital structures, non-core business activities, and more – so you use it primarily to be “complete” and ensure that you’ve covered all the common multiples.

Question 35

What are the advantages and disadvantages of FCF vs. Unlevered FCF vs. Levered FCF?

Answer 35

• Advantage of Unlevered FRF
  
  • Capital structure-neutral; company’s cash flow will be the same regardless of its Cash, Debt, and Preferred Stock. It’s also easier and faster to calculate than the others
• You’d use FCF or Levered FCF if you want to take into account the company’s capital structure, and you’d use Levered FCF to be slightly more accurante since it includes mandatory debt repayments
• You almost always use Unlevered FCF in a DCF analysis to value a company; FCF is more common for standalone financial statement analysis

Question 36

When you use EBITDAR in the EV/EBITDAR multiple, how muct you adjust EV?

Answer 36

If the denominator of a valuation multiple excludes expense, then the numerator should include the BS item corresponsing to that expense (and vise versa)

EBITDAR = EBITDA + Rental Expense, so it excludes annual rental expense by adding it back.

So, with EBITDAR and EV/EBITDAR, you have to capitalize the company operating leases, usually multiplying the annual lease expense by 7x or 8x, and then add the capitalized leases to EV

Question 37

Could levered FCF ever be higgher than unlevered FCF?

Answer 37

Yes, because levered FCF includes Net Interest Expense, so if the company had a negative value for that figure (i.e. it earned more interest than it spent on interest expense), and it also had minimal debt repayments, then levered FCF might be higher. This is very unusual

Question 38

If EBITDA decreases, how do Unlevered and Levered FCF change?

Answer 38

EBITDA includes only Rev, COGS, and Operating Expenses.

If EBITDA decreases they both decrease

Question 39

What are 3 different ways to calculate unlevered FCF?

Answer 39

1. EBIT*(1-Tax Rate) + Non-Cash Adjustments + Net Changes in Working Capital - CapEx
2. (EBITDA - D&A)*(1-Tax rate)+ Non-Cash Adjustments + Net Changes in Working Capital - CapEx
3. CFO - (Net Interest Expense and other items between operating income and pretax income)*(1-tax rate)-capEx

Question 40

When you calculate Unlevered FCF starting with EBIT*(1-Tax) or NOPAT, you’re not counting the tax shield form the interest expense. Isn’t that wrong?

Answer 40

No, it’s correct.

If you’re excluding the impact of a company’s capital structure, you have to exclude EVERYTHING related to its capital structure.

Question 41

Two companies have the same P/E multiples but different EV / EBITDA multiples. How can you tell which one has more debt?

Answer 41

You need to know the size of the companies to answer this question. The multiples might be similar, but it doesnt mean that the number in the num/denom are similar (they could just be proportional to each other)

Question 42

How do you decide whether to use Equity Value or Enterprise Value when you create valuation multiples?

Answer 42

You look at which group of investors this operational metric is available:

all investors? then EV

equity investors? then Equity value

Question 43

Should you use Equity Value or Enterprise Value with FCF?

Answer 43

It depends on the type of FCF. If it includes Net Interest Expense, then it is levered FCF so you use Equity Value. If it doesn’t, use EV

Question 44

Two Companies have the same amount of debt, but one company has convertible debt, and the other has traditional debt.

Both companies have the same operating income, tax rate, and equity value. Which company will have a higher P/E multiple?

Answer 44

Since the interest rates on convertible debt are lower than tradiitonal debt, the company with convertible debt will have a lower interest expense and therefore a higher net income.

As a result, its P/E multiple will be lower (NE is in the denom). So company with convertible debt will have a lower P/E multiple, and the company with traditional debt will have a higher P/E multple.

Question 45

Is it accurate to subtract 100% of the cash balance when moving from EqV to EV?

Answer 45

NO, but everyone does it anyway. It’s wrong because companies always need some portion of cash to continue running its business; thus, that portion of cash could be considered a “core-business asset”

Question 46

Why do you NOT subtract Goodwill when moving from EqV to EV? The company doesn’t need it to continue operating its business.

Answer 46

Goodwill is a core-business asset, so you should NOT subtract it when moving to EV.

Remember that Goodwill reflects the premiums paid for companies that the company previously acquired - if you subtracted it, you’d be saying, “those previous acquisitions are NOT a part of this company’s core business anymore.”

This is only true if the business has shut down or solf those companies

Question 47

Why might you subtract only part of a company’s DTA when calculating EV?

Answer 47

DTA’s can contain many different items, some of which are related to simple timing differences or tax xredits for operational items.

But you should subtract ONLY the NOLs that are in the DTA because those are non-operational in nature.

Question 48

Why might someone argue you should NOT add capital leases when moving from Equity Value to EV

Answer 48

Some people argue that capital leases are operational items since owning vs renting buildings is an operational decision, not a financial one.

If capital leases are “operational liabilities” and they do not represent another investor group, you should not add them in this calculation

Question 49

How do you factor in Working Capital when moving from Equity Value to Enterprise Value

Answer 49

You don’t. Remember that EqV represents the value of ALL the company’s Assets but only to equity investors.

So, you subtract items only if they are non-core-business assets

Question 50

Why do you add Noncontrolling Interests when moving from EqV to EV?

Answer 50

First, these NCI represent another investor group: another company that the parent company owns a majority stake in. EV reflects all the investor groups in a company, so you must add NCI.

Second, you need to do this for comparability purposes. Since the financial statements are consolidated 100% when the parent owns a majority staek in the other, metrics like EBIT and EBITDA include 100% of the other’s financials.

EqV, however, includes only the value of the actual percentage the parent owns.

So, if a parent owns 70% of the other, the parent’s EqV will include the value of that 70% stake. But its EBIT and EBITDA reflect 100%.

Thus, we add the 30% the company DOES NOT OWN - the NCI.