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IB Technicals Equity and Enterprise Value

Enterprise value represents the total value of a company including both equity and debt, while equity value only considers the value attributable to shareholders. Enterprise value is used more often in M&A valuations and is calculated by taking the market value of equity and either adding or subtracting various balance sheet items like debt, cash, and preferred stock. Equity value is simply market capitalization and only considers the value to shareholders.

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47 views10 pages

IB Technicals Equity and Enterprise Value

Enterprise value represents the total value of a company including both equity and debt, while equity value only considers the value attributable to shareholders. Enterprise value is used more often in M&A valuations and is calculated by taking the market value of equity and either adding or subtracting various balance sheet items like debt, cash, and preferred stock. Equity value is simply market capitalization and only considers the value to shareholders.

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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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M&A

Technicals
Specially curated for IB internships interviews
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ Enterprise Value /

Enterprise value (EV), or Total Enterprise Value (TEV), is the


value of a company’s core business operations that is
available to both equity and debt shareholders.

It is an important metric in M&A, as it tells the acquirer the


value of its target. Enterprise value thus becomes an
important measure for various valuation methodologies
including trading multiples like EV/Revenue, EV/EBITDA, and
EV/Sales. To calculate enterprise value from equity value,
subtract cash and cash equivalents and add debt, preferred
stock, and non-controlling interest.

N.B: Despite that you can abbreviate both Equity and


Enterprise Value as “EV”, “EV” stated on its own will always
refer to the Enterprise Value
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ Equity Value /

The equity value of a company is equal to its market


capitalization.

Market capitalization, or market cap, is the current market


value of the company’s outstanding shares. Mathematically,
it is the price per share times the # of shares outstanding. It
dictates the total value of the company that is attributable to
equity investors. Thus, equity value is the basis for various
valuation methodologies including trading multiples like P/E
and Price/Book Value.

Note that the market equity value of a company is not the


same as its book equity value, which stated on the balance
sheet as the difference between assets and liabilities.
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ The difference between both /

Both measures are utilised in various valuation


methodologies.

When deciding which one to use, opt for equity value if your
metric involves changes in debt and interest.

Alternatively, choose enterprise value if it excludes changes


in debt and interest.

The rationale for using enterprise value before deducting any


interest or debt lies in the fact that this cash flow is available
to both debt and equity shareholders, unlike equity value
which is only available for equity shareholders.

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Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ The difference between both /

Therefore, there are differences when discounting future


cash flows to their present values.

Discounting levered free cash flows (cash flow available to


only equity shareholders) is done by using the cost of equity,
as the calculation only concerns equity investors.

In contrast, when calculating enterprise value, unlevered


free cash flows (cash flow available to both debt and equity
shareholders) are discounted by Weighted Average Cost of
Capital (WACC) as now the calculation includes all investors.

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Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ The difference between both /

Enterprise value and its multiples are vastly more used for
valuation as a multiple like P/E is not capital neutral, making
it hard to compare companies.

However, there may be some industries where the P/E ratio


and equity value are more meaningful than enterprise value
and its multiples. For example, when valuing banks, financial
institutions, or insurance firms, P/E might be preferred as
these companies use debt differently than other companies
and interest is a major component of a bank’s revenue.
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ Outstanding Debt /

A company’s total debt is all the money it owes to lenders or


creditors. This includes both short- and long-term debt
appearing on the balance sheet as liabilities.

We add this amount to the EV calculation because when the


acquirer acquires the target it takes on the existing debt of
the target, increasing the cost of the acquisition.
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ Cash & Cash Equivalents /

We subtract this amount from EV because it will reduce the


acquiring costs of the target company.

This is because the acquirer will use the cash immediately to


pay off a portion of the theoretical takeover price.
Specifically, it would be immediately used to pay a dividend
or buy back debt.
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ Non-controlling Interest /

A non-controlling interest, or a minority interest, pertains to


a circumstance when a company possesses a minority
stake in another company, or a stake that controls less than
50% of a company's total shares.

The financial statements of this subsidiary are consolidated


in the financial results of the parent company. Thus, we need
to add this noncontrolling interest to the EV calculation as the
parent company includes 100% of the revenues, expenses,
and cash flow in its numbers even though it doesn’t own 100%
of the business.
Technical: What is the difference between
Enterprise and Equity Value

Enterprise VS Equity Value


/ Preferred Stocks /

Preferred stocks are a type of stock that have features of


both equity and debt. In contrast to common stock, they are
treated more as debt because they pay a fixed amount of
dividends, are higher on the capital structure, and have
higher earning claims than common stock shareholders. In
an acquisition, they normally must be repaid just like debt.
Thus, we need to add preferred stock in the EV calculation.

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