EV/EQV (Other)

Question 1

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 the company has (i.e., ALL its Assets), but
only to COMMON EQUITY INVESTORS (i.e., shareholders).
Enterprise Value represents the value of the company’s CORE BUSINESS OPERATIONS (i.e.,
ONLY the Assets related to its core business), but to ALL INVESTORS (Equity, Debt, Preferred,
and possibly others).

Question 2

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

Answer 2

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 it’s worth
based on your views and analysis.
You calculate Current Enterprise Value for public companies by starting with Current Equity
Value, subtracting non-core-business Assets, and adding Liability and Equity line items that
represent different investor groups.
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 3

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

Answer 3

Remember that Company Value = Cash Flow / (Discount Rate – Cash Flow Growth 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 4

5. Everyone knows how you move from Equity Value to Enterprise Value But WHY do you subtract Cash, add Debt, add Preferred Stock, and so on?

Answer 4

You subtract Assets when they represent non-core-business Assets. Cash and Investments are
examples, but Equity Investments (AKA Associate Companies), Assets Held for Sale, and Assets
Associated with Discontinued Operations also count.
You add Liability & Equity line items when they represent different investor groups beyond the
common shareholders. Debt and Preferred Stock are the most common examples, but
Unfunded Pensions and Capital Leases (among others) also qualify.

Question 5

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

Answer 5

Because Enterprise Value reflects the value of a company’s core business operations to ALL
investors in the company.
That definition means that if something does not affect the company’s core business, it won’t
affect Enterprise Value.
Issuing Dividends, issuing Stock, repurchasing Stock, issuing/repaying Debt, etc. do not impact a
company’s core business, so they do not affect Enterprise Value.
Note that in reality, there will still be a small impact on Enterprise Value; this is just the theory.

Question 6

11. If financing-related events do not affect Enterprise Value, what DOES affect it?

Answer 6

Only changes to a company’s core business will affect Enterprise Value. For example, the
company wins a major new customer contract, or it announces higher-than-expected sales, or it
closes a factory, or it announces positive results from an expansion strategy into Africa.
But remember that this is all in theory. In reality, financing changes will still make a small impact
on Enterprise Value.

Question 7

12. If a company wins a major contract with a new customer, will ONLY Enterprise Value
    change? Or will Equity Value also change?

Answer 7

Equity Value will change as well. The whole point of Equity Value is that it is affected by BOTH
operational and financial changes, whereas Enterprise Value is affected by ONLY operational
changes (in theory).

Question 8

13. Why does Enterprise Value NOT necessarily represent the “true cost” to acquire a
    company?

Answer 8

First, because the buyer may not necessarily have to repay the seller’s Debt – in 99% of cases,
they do, or they have to “refinance it” by replacing it with new Debt, but there are exceptions.
Second, the buyer may not “get” the seller’s entire Cash balance. The seller needs a certain
minimum amount of Cash to continue operating, and so the seller’s Cash may not reduce the
effective purchase price 1-for-1.

Finally, the buyer has to pay additional fees for M&A advisory, accounting, legal services, and
financing to acquire another company, and none of those is reflected in Enterprise Value

Question 9

14. 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, their Enterprise
    Values will be the same.
    Why is this NOT true in reality?

Answer 9

Because a company’s capital structure, whether current, optimal, or targeted, impacts the
Discount Rate you use to calculate the Implied Enterprise Value (and by extension, the Discount
Rate “the market as a whole” uses to value a company for its Current Enterprise Value).
Not only do the percentages of Equity, Debt, and Preferred Stock change WACC, but the Costs
of all these items also change as the company’s capital structure changes.
For example, more Debt will initially reduce WACC because Debt is cheaper than Equity. But
past a certain point, additional Debt will start to increase WACC because the risk to all investors
starts increasing at that stage.
Enterprise Value will be LESS affected by capital structure changes than Equity Value, but there
will still be some impact even from relatively small changes.

Question 10

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

Answer 10

Equity Value increases by $200 million because of the new shares, but Enterprise Value stays
the same because the $200 million of extra Cash offsets the higher Equity Value.
The P / E multiple increases, but EV / EBITDA stays the same.

Question 11

2. A company issues $200 million in new shares, but it will use $100 million from the proceeds
   to issue Dividends to shareholders. How does everything change?

Answer 11

In this case, Equity Value increases by $200 million but then falls by $100 million because
Dividends reduce Equity Value, so Equity Value is up by only $100 million.
The company ends up with $100 million in cash. Enterprise Value stays the same because, once
again, the extra Cash offsets the higher Equity value.
The P / E multiple increases, but by less than in the previous question, and EV / EBITDA stays
the same.

Question 12

3. The company decides to use $200 million it raised through new share issuance to acquire another business for $100 million. How does everything change?

Answer 12

Once again, Equity Value increases by $200 million initially, and Enterprise Value does not
change. However, after the company spends $100 million of Cash to acquire another company
– a core-business Asset – its Enterprise Value will increase by $100 million.
Its Equity Value will NOT change in this step because Equity Value does not distinguish between
core and non-core Assets; it includes the values of all Assets.
So the company’s Equity Value increases by $200 million, its Enterprise Value increases by $100
million, and both the P / E multiple and the EV / EBITDA multiple increase.

Question 13

4. What if the company uses a $100 million it just raised to acquire an Asset rather than an entire
   company?

Answer 13

Once again, Equity Value increases by $200 million initially and does not change after the Asset
acquisition because the type of Asset acquired is irrelevant to Equity Value.
If this acquired Asset is a core-business Asset – for example, a factory – then the company’s
Enterprise Value will increase by $100 million. If it is not – for example, a short-term investment
– then the company’s Enterprise Value will not change.
So regardless of the classification, the P / E multiple increases. But the EV / EBITDA multiple
may or may not increase, depending on the type of Asset acquired.

Question 14

5. What changes with everything above if the company raises $200 million in Debt to do this
   instead?

Answer 14

The main difference is that Equity Value no longer changes, and so the P / E multiple no longer
changes. Enterprise Value also doesn’t change because the extra Cash and extra Debt cancel
each other out.
However, as in the previous questions, if the company uses the Cash to acquire another
company or other core-business Assets, Enterprise Value and EV / EBITDA both increase.
If the company raises $200 million of Debt to issue $100 million in Dividends, Enterprise Value
and EV / EBITDA will stay the same through all of that, but Equity Value will decrease by $100
million because of the Dividends, and so the P/E multiple will also decrease.

Question 15

6. Let’s say the company raises $200 million in Debt to acquire another company for a
   purchase price of $200 million. The other company’s Common Shareholders’ Equity is exactly
   $200 million. How does everything change?
7. How is this scenario different if the purchase price is still $200 million, but the other
   company has only $100 million in Common Shareholders’ Equity?

Answer 15

In the first step – a $200 million Debt issuance – neither Equity Value nor Enterprise Value will
change.
In the second step – an acquisition of another company for $200 million when its CSE is also
$200 million – the company’s Enterprise Value will increase by $200 million because this other
company counts as a core-business Asset.
So the P / E multiple stays the same and the EV / EBITDA multiple increases.

The only difference is that now the company has to record $100 million of Goodwill (or Other
Intangible Assets, or a combination of both) on its Balance Sheet.
However, both of those are core-business Assets, so Enterprise Value still increases by $200
million, and everything else is the same as in the previous question.

Question 16

8. What happens to everything if a company issues $100 in Dividends?

Answer 16

Equity Value decreases by $100 million, but Enterprise Value stays the same because the lower
Equity Value and lower Cash balance cancel each other out. Also, the Cash used to issue these
Dividends is a non-core-business Asset.
As a result, the P / E multiple falls, but the EV / EBITDA multiple stays the same.

Question 17

9. A company has a Current Equity Value of $200, $50 in Cash, and $100 in Debt. If the
   company spends $25 of its Cash balance to purchase PP&E, how does everything change?

Answer 17

The company’s Current Enterprise Value is: $200 + $100 – $50 = $250.
Its Equity Value won’t change when it uses $25 of Cash to purchase PP&E because Cash and
PP&E are the same – just Assets – from the perspective of Equity Value.
Its Enterprise Value will increase by $25 because the company has converted a non-corebusiness Asset into a core-business Asset. $200 + $100 – $25 = $275, so its Enterprise Value is
now $275.
As a result, its P / E multiple stays the same, but its EV / EBITDA multiple increases.

Question 18

10. A company has excess Cash. What are the valuation implications if it uses that Cash to
    repurchase shares vs. repay Debt?

Answer 18

Enterprise Value won’t change for either one. The reduced Cash balance offsets the reduced
Equity Value, and the reduced Cash Balance also offsets the reduced Debt balance.
However, Equity Value will decrease if the company repurchases shares.
So in a share repurchase, Equity Value and the P / E multiple will fall, but in a Debt repayment,
they’ll stay the same. And Enterprise Value and EV / EBITDA will stay the same for everything.

Question 19

11. 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 19

Equity Value will increase by $100 because you have to attribute this “free Cash” to some
investor group, and Equity investors make the most sense because Equity on the Balance Sheet
also represents what the company has saved up internally from its operations.

Enterprise Value will not change because Cash is a non-core-business Asset, and the extra Cash
offsets the higher Equity Value in the calculation.

Question 20

12. A company issues a press release indicating that it expects its revenue to grow at 20%
    rather than its previous estimate of 10%. How do EV/EQV
    change?

Answer 20

This represents a difference in the company’s core business: It expects higher sales growth.
As a result, both its Enterprise Value and Equity Value will increase. Its Equity Value will
increase because the company’s Total Assets are more valuable if they are expected to
generate higher growth.
And the Enterprise Value will increase because its core-business Assets are certainly more
valuable if they’re expected to generate higher growth.
The Intuition: If a company announces higher-than-expected growth, its share price almost
always jumps up, reflecting a higher Equity Value and a higher Enterprise Value.

Question 21

13. When there’s an operational change, how can you determine whether Equity Value or
    Enterprise Value will change by more?

Answer 21

Generally, Enterprise Value will change by more because it is affected only by these operational
changes. Since Equity Value is affected by both financial and operational changes, operational
changes tend to make less of an impact.

Question 22

15. You’ve explained that Equity Value represents the value of ALL assets.If that’s the case, why doesn’t a Debt issuance boost Equity Value? After all, if a company
    raises $100 in Debt, it gets $100 in extra Cash.

Answer 22

This is a trick question because the interviewer doesn’t state the LAST PART of the definition:
“The value of ALL assets but only to EQUITY INVESTORS.”
And that last part explains this effect: When a company’s Assets increase, if that increase is
funded by Debt (or any other non-equity investor), then Equity Value will not increase