IB 400 (Enterprise / Equity Value - Advanced)

Question 1

Are there any problems with the Enterprise Value formula you just gave me?

Answer 1

Yes - it’s too simple. There are lots of other things you need to add to the formula with real companies:

Net Operating Losses - Should be valued and arguably added in, similar to cash.

Long-Term Investments - These should be counted - similar to cash.

Equity Investments - Any investments in other companies should also be added in, similar to cash (though they might be discounted).

Capital Leases - Like debt, these have interest payments - so they should be added in like debt.

(Some) Operating Leases - Sometimes you need to convert operating leases to capital leases and add them as well.

Unfunded Pension Obligations - Sometimes these are counted as debt as well.

So a more “correct” formula would be Enterprise Value = Equity Value - Cash + Debt + Preferred Stock + Noncontrolling Interest - NOLs - LT and Equity Investments + Capital Leases + Unfunded Pension Obligations…

Question 2

Should you use the book value or market value of each item when calculating Enterprise Value?

Answer 2

Technically, you should use market value for everything. In practice, however, you usually use market value only for the Equity Value portion, because it’s almost impossible to establish market values for the rest of the items in the formula - so you just take the numbers from the company’s Balance Sheet.

Question 3

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

Answer 3

There’s no strict “rule” here but most bankers would say that anything over 10% is odd. If your basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check your calculations - it’s not necessarily wrong, but over 10% dilution is unusual for most companies.