Enterprise and Equity Value Flashcards
(18 cards)
- Why do we look at both Enterprise Value and Equity Value?
Enterprise Value (EV):
Represents total value of the business to all investors
Includes debt, preferred stock, minority interest, and subtracts cash
Reflects the true cost to acquire the business
Equity Value:
Represents value attributable only to common shareholders
Equals share price × shares outstanding
What the public market values the company at
Why we look at both:
Equity Value is what shareholders care about
Enterprise Value is used for valuation multiples like EV/EBITDA
Both help assess company value from different perspectives
- When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity Value?
You focus on Enterprise Value
An acquirer must pay for the company’s entire capital structure:
Common equity
Debt
Preferred stock
Minority interest
Enterprise Value reflects the true cost of acquiring the business, because the buyer takes on the company’s debt and gets access to its cash
Equity Value only tells you what the shareholders receive, not the full purchase cost
- What’s the formula for Enterprise Value?
Enterprise Value (EV) =
Equity Value
+ Debt
+ Preferred Stock
+ Minority Interest
– Cash and Cash Equivalents
Equity Value = Share Price × Fully Diluted Shares Outstanding
Debt includes both short-term and long-term borrowings
Cash is subtracted because it reduces the net cost to acquire the company
Preferred stock and minority interest are added because they represent other investor claims on the business
- Why do you need to add Minority Interest to Enterprise Value?
What is Minority Interest?
Let’s say Company A owns 80% of Company B.
Because it owns more than 50%, Company A is required to combine 100% of Company B’s financials into its own accounts — this is called consolidation.
But Company A only actually owns 80% of the equity — the other 20% belongs to outside investors.
That 20% is called the Minority Interest.
Why is this a problem in valuation?
When we calculate Enterprise Value, we want it to reflect the value of the entire company, including everything shown in its financials.
If EBITDA includes 100% of Company B’s EBITDA, then EV must also reflect 100% of the value — even though Company A doesn’t own all of it.
So we add Minority Interest to Enterprise Value to reflect the portion of the subsidiary that isn’t owned, because the EBITDA includes all of it.
- How do you calculate fully diluted shares?
What are “fully diluted shares”?
These are the total number of shares that could exist if all stock options, warrants, or convertible securities were turned into shares.
It’s the number you use when calculating the true value of a company to shareholders.
Why does this matter?
Because when valuing a company, you want to account for all possible shares that could dilute existing shareholders.
What is the Treasury Stock Method?
The Treasury Stock Method (TSM) is used to estimate how many extra shares will exist if employees exercise options.
But:
When options are exercised, the company receives cash
It is assumed the company uses that cash to buy back some of its own shares
So you’re adding some shares from option exercises but subtracting some because the company uses the cash to repurchase shares.
Steps (Treasury Stock Method):
1. Count all in-the-money options
2. Assume they are exercised → increases total shares
3. Calculate cash received = number of options × exercise price
4. Assume that cash is used to repurchase shares at current share price
5. Net increase in shares = new shares from option exercises – shares repurchased
- Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each – what is its fully diluted equity value?
Step-by-step (TSM):
1. Count all in-the-money options (100)
2. Assume they are exercised → increases total shares (100+10=110)
3. Calculate cash received = number of options × exercise price (10x5=$50)
4. Assume that cash is used to repurchase shares at current share price ($50/$10=5 shares repurchased)
5. Net increase in shares = new shares from option exercises – shares repurchased
The company receives cash (10 created – 5 repurchased = 5)
6. Final fully diluted share count = 100 basic shares + 5 net new shares = 105 fully diluted shares
7. Fully diluted equity value = 105 shares x $10 = $1050
- Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each – what is its fully diluted equity value?
Step 1: Are the options in-the-money?
The exercise price ($15) is higher than the current share price ($10)
That means the options are out-of-the-money
What does that mean?
No rational investor would pay $15 to buy a share that’s only worth $10
So these options would not be exercised
They are ignored when calculating fully diluted shares
Step 2: Calculate Fully Diluted Shares
Since the options aren’t exercised, the company still only has 100 shares outstanding
Fully diluted shares = 100
Step 3: Calculate Fully Diluted Equity Value
Fully diluted equity value = Share price × Fully diluted shares
= $10 × 100 = $1,000
Final Answer:
Fully diluted equity value = $1,000
The 10 options are ignored because they’re out-of-the-money
- Why do you subtract cash in the formula for Enterprise Value? Is that always accurate?
Why do you subtract cash?
You subtract cash because Enterprise Value reflects the net cost to acquire a company’s core operations
When you buy a company, you assume its debt (a cost to you), but you also gain access to its cash (a benefit to you)
Cash can be used to repay debt or fund operations, so it reduces the true cost of acquisition
Is it always accurate?
Mostly, yes, but not always:
You generally subtract excess or idle cash, not cash that’s required for operations
If cash is trapped overseas due to tax rules or needed to run the business, then subtracting all cash might overstate the discount
So subtracting cash is a standard convention, but analysts sometimes adjust the amount based on how accessible or “excess” the cash really is.
- Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?
Enterprise Value = Equity Value + Debt + Preferred Stock + Minority Interest – Cash
You normally add debt to reflect the total value of the company — not just the portion held by shareholders.
Why Debt Is Usually Added
If you’re acquiring a company, you take on:
Its equity (you pay shareholders)
And its debt (you assume or repay loans)
So to reflect the total cost to acquire the business, you add debt
This includes:
Short-term debt
Long-term debt
Bank loans
Corporate bonds
But is it always accurate?
Not necessarily. Some financial instruments act like equity, even if they are legally debt.
The most common example is convertible bonds.
What are convertible bonds?
Bonds that can be converted into shares
They start off as debt, but might turn into equity if the share price goes high enough
How do you treat them in valuation?
If the convertible bond is out-of-the-money (conversion price > share price):
It’s unlikely to convert → treat it as debt
So add it to Enterprise Value
If it’s in-the-money (conversion price < share price):
It will likely convert → treat it as equity
Include the converted shares in the share count
Do not add it as debt
In general:
Normal debt (loans, bonds) always added to Enterprise Value
Convertible debt (out-of-the-money) add to EV as debt
Convertible debt (in-the-money) included in share count, not added to EV
- Could a company have a negative Enterprise Value? What would that mean?
Yes — a company can have a negative Enterprise Value, and it usually means:
The company has very high cash reserves
And/or a very low Equity Value (market cap)
Enterprise Value = Equity Value + Debt + Preferred Stock + Minority Interest – Cash
If cash is greater than the sum of equity value and debt, EV can be negative.
When would this happen?
Distressed or declining businesses trading at very low valuations
Cash-rich companies that the market believes won’t grow
Companies in industries like:
Retail
Natural resources
Small-cap tech
What does it mean?
The market may believe the core operations have little or no value
In extreme cases, it may imply the company’s cash is worth more than the business itself
Could signal:
A bargain (undervalued cash-rich company)
Or a red flag (market expects losses, cash burn, or failure)
- Could a company have a negative Equity Value? What would that mean?
In theory, yes — but in practice, almost never.
Equity Value (Market Cap) = Share Price × Shares Outstanding
Share price can’t be negative, and neither can shares outstanding
So public companies can’t have negative Equity Value
What people usually mean is: negative Shareholders’ Equity
This shows up on the Balance Sheet:
Shareholders’ Equity = Assets – Liabilities
If liabilities are greater than assets, Shareholders’ Equity becomes negative
What does negative Shareholders’ Equity mean?
The company has accumulated more losses or debt than assets
It could indicate:
Ongoing losses
Large dividend payments in the past
Write-downs or impairments
Often seen in distressed companies, or those with lots of debt-funded buybacks
But Equity Value (Market Cap) can still be positive
The market may still believe the company has future value, even if the Balance Sheet looks weak
So a company can have:
Negative Shareholders’ Equity
But positive Market Cap / Equity Value
- Why do we add Preferred Stock to get to Enterprise Value?
Preferred stock (or preference shares) is a type of hybrid security — it shares characteristics of both equity and debt.
How it’s like equity:
It’s part of the company’s share capital — issued alongside common shares
Preferred shareholders often don’t get voting rights
It shows up in the Equity section of the Balance Sheet
How it’s like debt:
It pays a fixed dividend, like interest on a bond
That dividend is usually mandatory — the company must pay it before paying common shareholders
In liquidation, preferred shareholders have priority over common shareholders (but still rank below debt holders)
Why does it matter in valuation?
If you’re acquiring a company, you’ll likely have to buy out the preferred shareholders
Holders of preferred stock have priority over common shareholders in terms of dividends and liquidation
In many cases, preferred dividends are fixed and mandatory, making preferred stock behave more like debt
If you acquire a company, you typically have to repay or assume the preferred stock, just like you would with debt
So, to reflect the true cost of acquiring the business, you add Preferred Stock to Equity Value to calculate Enterprise Value
- How do you account for convertible bonds in the Enterprise Value formula?
It depends on whether the convertible bonds are in-the-money or out-of-the-money:
If the convertible bonds are in-the-money:
The current share price is above the conversion price
Investors will likely convert their bonds into shares
So you treat the convertibles as equity, not debt
Do not add them to Enterprise Value
Instead, include the additional shares from conversion in the fully diluted share count when calculating Equity Value
If the convertible bonds are out-of-the-money:
The share price is below the conversion price
Investors will not convert — they’ll just receive repayment like normal debt
So treat them as debt
Add the face value of the bonds to Enterprise Value
- A company has 1 million shares outstanding at a value of $100 per share. It also has $10 million of convertible bonds, with par value of $1,000 and a conversion price of $50. How do I calculate diluted shares outstanding?
Step 1: Determine if the bonds are in-the-money
Current share price = $100
Conversion price = $50
Since $100 > $50, the bondholders would definitely convert — they’d rather own shares worth $100 than hold a bond worth $1,000.
So: the bonds are in-the-money → assume they’ll be converted into shares.
Step 2: Find how many bonds exist
Total value of convertible bonds = $10 million
Each bond = $1,000 par value
Number of bonds = $10 million ÷ $1,000 = 10,000 bonds
Step 3: Calculate shares per bond
Conversion price = $50
Each $1,000 bond converts into $1,000 ÷ $50 = 20 shares
Step 4: Total new shares from conversion
10,000 bonds × 20 shares per bond = 200,000 new shares
Step 5: Add to basic shares
Existing shares = 1,000,000
New shares from convertibles = 200,000
Fully diluted shares = 1,200,000
- What’s the difference between Equity Value and Shareholders’ Equity?
Equity Value (also called Market Capitalisation):
Market-based measure
Calculated as:
Equity Value = Share Price × Fully Diluted Shares Outstanding
Represents the market value of a company’s equity
Used in valuations, M&A, trading comps
Forward-looking — reflects what investors are willing to pay
Shareholders’ Equity (also called Book Value of Equity):
Accounting-based measure
Found on the Balance Sheet
Calculated as:
Shareholders’ Equity = Assets – Liabilities
Represents the book value of the company’s net assets
Based on historical costs, not current market prices
- Are there any problems with the Enterprise Value formula you just gave me?
Yes — while the standard formula is widely used, it has some limitations and potential issues depending on how detailed you need to be.
Enterprise Value = Equity Value + Debt + Preferred Stock + Minority Interest – Cash
Potential problems:
Not all cash is equal
Some cash is restricted or needed for day-to-day operations and shouldn’t be subtracted
Not all debt is equal
Some debt may be non-interest bearing, or certain lease liabilities may or may not be included depending on accounting standards (e.g. IFRS 16)
Ignoring other non-operating assets or liabilities
Enterprise Value should reflect the value of the core business only
If a company owns significant investments, non-core assets, or pension liabilities, these should be adjusted for
Treatment of convertible debt
Depends on whether it’s in-the-money or not (as explained earlier)
- Should you use the book value or market value of each item when calculating Enterprise Value?
Use market value wherever possible, especially for Equity Value, because Enterprise Value aims to reflect what the business is worth today to investors.
Market value used for:
Equity Value = Share Price × Fully Diluted Shares (always market value)
Preferred Stock = Use market value if available; otherwise use liquidation or par value
Minority Interest = Usually no market value available → use book value
Debt = Ideally use market value, but often book value is used as a proxy
If debt trades significantly above/below par, adjust accordingly
Cash = Book value usually fine (cash = cash)
- What percentage dilution in Equity Value is “too high?”
Dilution happens when a company has — or could have — more shares in the future than it does now. That means each existing shareholder owns a smaller percentage of the company, and their claim on profits, dividends, and voting power goes down.
There’s no strict threshold, but in most cases:
More than 10–15% dilution is considered significant
Over 20–25% is often seen as too high and raises concerns
Why dilution matters:
Dilution means existing shareholders own less of the company
It affects per-share metrics like:
EPS (Earnings Per Share)
Equity Value per share
Heavy dilution can reduce investor confidence and impact valuation
When does dilution occur?
From things like:
Stock options
Convertible bonds
Warrants
Equity raises
How to evaluate it:
Compare basic vs fully diluted share count
Consider whether dilution is already priced in or might increase further
Consider why dilution exists — e.g. equity compensation vs financial distress
