Equity and Enterprise Value

Question 1

What is equity value? How do you calculate it?

Answer 1

Equity value represents the value of a company made available to common shareholders. Dependent on capital structure.

Equity value = price/share * diluted shares

Question 2

What is enterprise value? How do you calculate it?

Answer 2

Enterprise value is the total value of a company’s operations. Not dependent on capital structure.

EV = Equity + debt + preferred + minority - cash (and other non-operating assets like marketable securities)

Question 3

Use an analogy to explain enterprise and equity value

Answer 3

Let’s use the example of buying a house. Equity value is like the down payment, how much money you put down to call yourself the owner. However, enterprise value is the cost of the house, mortgage included. Enterprise value means that beyond buying ownership rights (paying of shareholders), you also need to assume the debts.

Question 4

Give me examples of the following
1. Transaction that changes equity val but not enterprise val
2. Changes enterprise val but not equity val
3. Changes both

Answer 4

1. New shares issued, and cash sits in account
2. Buying a factory, CapEx
3. Issuing shares to buy a factory

Question 5

Why do we need both equity and enterprise value? Why can’t we just use one?

Answer 5

Different valuation techniques give different metrics. E.g., using unlevered FCF gives EV while levered FCF gives equity value.

Question 6

Why do you subtract equity investments and add back noncontrolling interest when calculating enterprise value?

Answer 6

To make an apples to apples comparison. GAAP dictates that companies report 100% of the subsidiary’s EBITDAs as long as they own more than 50% of that subsidiary. However, the company’s EV will only reflect their true ownership share, so we need to make some adjustments such that we calculate multiples like TEV/EBITDAs, we aren’t overstating the value of the company.

Question 7

Should you add operating leases to Enterprise value calculations? What about financing leases?

Question 8

A company purchases $100 of Inventory using Cash. How do Equity Value and Enterprise
Value change?

Answer 8

EV increases by $100 since inventory is an operating asset. Equity doesn’t change.

Question 9

Now assume the Inventory is sold for $200 and walk me through how the entire process from beginning to end affects Equity Value and Enterprise Value.

Answer 9

Pretax income increases by 100, assuming 25% tax rate, NI increases by 75. Equity value increases by 75.

We were previously up $100 inventory, but we sold off all $100 as COGS. EV net 0.

Question 10

A company has 10,000 shares outstanding and a current share price of $20.00. It also has
100 options at an exercise price of $10.00, 50 Restricted Stock Units (RSUs), and 100 convertible bonds at a conversion price of $10.00 and a par value of $100. What is its Diluted Equity Value?

Answer 10

Options are exercised because they are in the money. 100*10 = $1000, with 100 shares created. However, 1000/20 = 50 shares are bought back.

50 shares from RSU.

Conversion rate = par value / conversion price = 100 / 10 = 10 shares/bond. 100 bonds gives 1000 shares.

1000 + 50 + 50 = 1100 new shares. 1100 + 10000 = 11100 shares, or equity value of $222,000

Question 11

What is the trick to all equity and enterprise value calculations?

Answer 11

Change in equity value equals change in common shareholder equity!

Change in enterprise value equals change in net operating assets. Accounts Receivable, Inventory, PP&E, Prepaid Expenses, Other non-financing assets