EV / Equity value - Basic Flashcards
Why do we look at both Enterprise Value (EV) and Equity Value?
Enterprise Value is the value of the company that is attributable to all owners
Equity Value is only the value attributable to shareholders.
We look at both because the public / new investors are concerned with the equity value (market cap of a public company, for example), but the enterprise value represents the true value.
When looking to acquire a company, do you pay more attention to equity or enterprise value?
Enterprise value, because you will have to assume any debt the company holds after you acquire it.
What is the enterprise value formula?
EV = Equity Value + Debt + Preferred Stock + Non-Controlling Interest - Cash
Why do you need to add the Non-Controlling Interest to EV?
When a company owns over 50% of another company, it is required to report the financial performance of the other company as its own.
You must therefore consider the minority interest to understand what 100% of the company’s EV is (otherwise EV would only represent your controlling share).
How do you calculate fully diluted shares?
Take the basic share count and add the dilutive effect of stock options, warrants, convertible debt or convertible preferred shares.
A company has 100 shares outstanding at a share price of $10 each. It also has 10 options outstanding at a strike of $5 each - what is the fully diluted equity value?
Basic equity value: 100 shares x $10 = $1,000
First, note that all shares are “in the money”.
If all options are exercised, there will be 10 new shares issued for $5 each. Share count is now 110 and cash goes up by $50.
The additional cash is used to buy back 5 of the newly-created shares, therefore the fully-diluted share count is 105 and equity value is $1050.
A company has 100 shares outstanding at a share price of $10 each. It also has 10 options at a strike of $15 each - what is the fully diluted equity value?
100 shares x $10 = $1,000.
As the strike price of the options is above the market value of the shares, the options would not be exercised and therefore have no dilutive effect.
Why do you subtract cash in the formula for Enterprise Value? Is that always true?
Enterprise Value tells us how much a Buyer would have to ‘pay’ to acquire a business. Buyers pay $ for $ for cash usually, so any cash reduces the purchase price.
In some cases, a minimum level of cash is required to operate the business, so the Buyer would only pay $ for $ for excess cash above the minimum level.
Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?
Usually yes, because debt often has to be refinanced in an acquisition. Also, the Buyer will have to pay off the Seller’s debt.
There may be cases where this is not the case, but unlikely.
Can a company have a negative Enterprise Value? What would that mean?
It means the company has an extremely large cash balance relative to its market cap. You see it with:
- Companies on the brink of bankruptcy
- Financial institutions, such as banks, that have large cash balances (EV not used for commercial banks so this measure is irrelevant).
Could a company have a negative Equity Value? What would this mean?
No - you cannot have a negative share count or a negative share price.
Why do we add preferred stock to arrive at Enterprise Value?
Preferred Stock pays out a fixed dividend and sits higher in the pref stack than common equity, therefore it is seen as debt-like when bridging from Equity Value - Enterprise Value.
How do you account for convertible bonds in Enterprise Value?
If the convertible bonds are in the money, then you count them as additional dilution to the Equity Value.
If the bonds are out of the money, you count the face value of the bonds as part of the company’s Debt.
A company has 1 million shares outstanding at a value of $100 per share. It also has $10mm of convertible bonds, with a par value of $1,000 and a conversion price of $50. How do you calculate diluted shares outstanding?
Note the convertible bonds are in-the-money as the share price is $100, but the conversion price is $50. They are therefore counted as additional shares rather than debt.
Divide the value of the bonds ($10mm) by the par value ($1,000) to figure out how many bonds we have (10,000 units).
We figure out how many shares the number represents: $1,000 par value / $50 conversion price = 20 shares per bond
20 shares per bond x 10,000 bonds = 200,000 new shares.
Total diluted share count is 1,200,000 shares.
Treasury share method is not used for convertible debt, as the company does not receive cash when the bonds are exercised.
What is the difference between Equity Value and Shareholders’ Equity?
Equity Value is the market value of the company’s shares, but Shareholders’ Equity is the book value.
Equity Value can never be negative, but SE can be negative.
For healthy companies, Equity Value usually exceeds Shareholders’ Equity.
