EV - Equity

Question 1

What are EV and Equity values?

Answer 1

EV represent core business to all investors; equity value represents entire business but only to shareholders. You look at equity value because it’s the number the public sees, but EV represents its true value.

Question 2

How do you get from Equity Value to EV?

Answer 2

EV = Equity Value + Debt + Preferred Stock + Minority Interest – Cash (Simplified)
EV =
Equity
- Excess Cash
\+ Financial Debt
\+ Pref. Stock
\+ Minority Interest/NCI 
- Market Value of Non-Core Assets/Equity Investments/Long-Term Investments
- Net Operating Losses (NLO)
\+ Capital Leases (sometimes you have to convert them to operating leases and add them)
\+ Any other interest-bearing provisions
\+ Pension Obligations

Question 3

How would you calculate Net Debt?

Answer 3

Net Debt =
Financial debt
\+ Pension Liabilities
\+ Asset Retirement Obligations
\+ Any other interest-bearing provisions
- Excess Cash (trapped cash etc.)

Question 4

A company is valued. While looking at BS you find accruals for non-interest bearing legal fees. In 2 years, either €50m have to be paid or not. Chances are 50:50 (therefore €25m accrual). Is accrual considered for valuation?

Answer 4

If Company was valued using DCF and €25 was rightly included in CFs then we can ignore it in EV-Equity Bridge.

Question 5

Why do you add Minority Interest to EV?

Answer 5

You handle majority interest as part of own performance so you have to consider minority interest (usually <50%) as well to also reflect its value in EV. If minorities own stock of company as well you have to pay them too to buy the entire company.

FS are consolidated so EBITDA, EBIT etc. contain 100% of subsidiary (even if only 70% is owned). NI contains only associated percentage so if you want to do EV/EBITDA you can’t compare 70% vs. 100%. You therefore add minority interest to get entire subsidiaries value included in EV.

Question 6

Why do you subtract cash in the EV – Equity bridge?

Answer 6

Cash is considered a non-operating asset and because equity value implicitly accounts for it. Intuitively: Buyer gets cash from Seller so if you would pay for it you would just get the same amount of cash back.

Question 7

Why do you add Pref. Stock to get to EV?

Answer 7

Preferred stockholders get fixed dividend and have higher claim to company’s assets than equity investors, so it is more similar to debt than equity.

Question 8

Why do you subtract Investments in Associates?

Answer 8

EV only reflects core assets. Financial investments and minority interest in other companies is not included. Similar intuition to Excess Cash: Buyer could pay for all assets then sell Investments in Associates etc. to refinance the investment. Other intuition: Contrary to majority investments, Inv. In Associates are not consolidated in FS. Therefore, if you want to calculate EV/EBITDA etc. you can’t compare them if you have 30% vs. 0% of company included and therefore have to subtract investments.

Question 9

Are there cases when you wouldn’t subtract investments in Associates?

Answer 9

Yes, if they are part of the core business. Also, if they have a material impact on financial statements even though they are not consolidated.

Question 10

Why do you only subtract interest-bearing liabilities from EV and not just all operating liabilities like those for suppliers etc.?

Answer 10

Non-interest-bearing liabilities are no real financing components as they are not touched in valuation. Liabilities to suppliers are WC and therefore a constantly repeating operating position without interest payments. Suppliers therefore also don’t have any eligibility to receive part of profits like equity or debt investors do.

Question 11

Is negative EV possible?

Answer 11

Yes, large cash balance or low market cap (or both). Companies with negative EVs are usually on the brink of bankruptcy or financial institutions with large cash balances.

Question 12

Is negative Equity Value possible?

Answer 12

No, no negative share count nor share price possible.

Question 13

Is Equity Value > EV possible?

Answer 13

Yes, e.g. if there are a lot of non-core assets.

Question 14

Do you pay more attention to EV or Equity Value in valuation?

Answer 14

EV for three reasons:

• Equity is subject to changes in capital structure and can vary widely
• Equity Value depends on EV (valuation results in EV that is then calculated back to Equity)
• In acquisition, EV has to be paid

Question 15

A company raises €2b in new money from a bond. How does EV change?

Answer 15

Not at all. Cash and debt increase by €2b, so cancel each other out in ND.

Question 16

How do you calculate fully diluted shares?

Answer 16

Take basic share count and add in the dilutive effect of stock options and other dilutive securities such as warrant, convertible debt or convertible preferred stock. To calculate the dilutive effect, use the Treasury Stock Method

Question 17

A company has 100 shares outstanding at a share price of $10 each and 10 outstanding options at an exercise price of $5 each – what is the fully diluted equity value?

Answer 17

Basic equity value is $1’000 (100 * $10). All options are in the money ($5 < $10). To exercise the options, each owner has to pay $5 to the company, so the proceeds for the company are $50. Since each option is exercised, 100 new share get created. The company uses its proceeds to buy back 5 new shares and reach a fully diluted equity value of $1’050.

Question 18

A company has 100 outstanding shares at $10 and 10 outstanding options at an exercise price of $15. What is the fully diluted value of the shares?

Answer 18

$1’000. The options aren’t exercised so company doesn’t get additional money.

Question 19

A company has 1m stock outstanding @€10. Management has 250k Options at a strike price of €8. NI equals €2m. What are Basic and Fully Diluted EPS?

Answer 19

Basic: €2m / 1m = €2
Fully Diluted: All options are exercised so 250k * €8 proceeds = €2m. So 250k new stocks are created but money allows to buy 200k stocks back, so we end up with 1.05m stocks. Fully Diluted EPS = €2m / 1.05 = 1.9

Question 20

How are Fully Diluted EPS calculated when a company has Convertible Debt?

Answer 20

A convertible bond allows conversion into stock at predefined bond:stock ratio. Besides new stock, one has to recalculate NI as Convertible Bonds no longer exist and therefore no interest has to be paid.

Question 21

What percentage dilution in Equity value is “too high”?

Answer 21

No strict rule but probably everything over 10% is unusual (so diluted equity value > equity value * 1.1)

Question 22

Would you use the Treasury Stock Method with convertibles?

Answer 22

No, because company gets no cash from the conversion as in an exercised option.

Question 23

Should you use book or market value when calculating EV?

Answer 23

Technically you should use market value for everything. In practice you often only use market value for Equity Value and use book value for rest because the market value of remaining items is often hard or impossible to establish

Question 24

How do you account for convertible bonds in the EV formula?

Answer 24

If the convertible bonds are in-the-money then you count them as additional dilution, otherwise you count their face value as part of the company’s debt

Question 25

Company has 1m shares outstanding at $100 per share. It also has $10m of convertible bonds, with par value of $1’000 and a conversion price of $50. What’s the diluted share amount?

Answer 25

Because share price is higher than conversion price (100>50) we count them as additional shares rather than debt. Next, we divide value of convertible bonds ($10m) by par value $1’000 to figure out how many individual bonds we get 10’000 ($10m / $1’000).

Next, we need to find out how many shares this number represents. The number of shares per bond is the par value divided by the conversion price and get 20 shares per bond ($1’000 / $50). So we have 200’000 new shares (20 * 10’000) created by the convertibles giving us 1.2m diluted shares outstanding.

We don’t use the Treasury Stock Method with convertibles because the company is not “receiving” any cash from us.

Question 26

What’s the difference between Equity Value and Shareholders’ Equity?

Answer 26

Equity Value is market value and Shareholders’ Equity is book value. Equity Value can never be negative because shares outstanding and share price can never be negative, whereas Shareholders’ Equity could be any value. For healthy companies, Equity Value usually far exceeds Shareholders’ Equity.

Question 27

A company has an outstanding total of in-the-money options and warrants for 15,000 shares. The exercise price of each of these options is $7. The average market price, however, for the reporting period is $10. What is the dilution?

Answer 27

Assuming all the options and warrants outstanding are exercised, the company will generate 15,000 x $7 = $105,000 in proceeds. Using these proceeds, the company can buy $105,000 / $10 = 10,500 shares at the average market price. Thus, the net increase in shares outstanding is 15,000 – 10,500 = 4,500.

This can also be found by simply using the last formula provided above. The net increase in shares outstanding is 15,000 (1 – 7/10) = 4,500.
n-(n*K/P)

Question 28

What does the Modigliani Miller model state?

Answer 28

Under certain conditions (no taxes and similar costs, efficient market) the capital structure of a company is irrelevant to its value. Cost of debt increases the more you take on but equity increases slower so weighted average (WACC) stays the same.