Enterprise / Equity Value - Basic

Why do we look at both Enterprise Value and Equity Value?
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Why do we look at both Enterprise Value and Equity Value?
Enterprise Value represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise value represents its true value.
When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity value?
Enterprise Value, because that's how much an acquirer really "pays" and includes the often mandatory debt repayment.
What's the formula for Enterprise Value?
EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash

(This formula does not tell the whole story and can get more complex. Most of the time you can get away with stating this formula in an interview, though).
Why do you need to add Minority Interest to Enterprise value?
Whenever a company owns over 50% of another company, it is required to report the financial performance of the other company as part of its own performance.

So even though it doesn't own 100%, it reports 100% of the majority-owned subsidiary's financial performance.

In keeping with the "apples-to-apples" theme, you must add Minority Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary.
How do you calculate fully diluted shares?
Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities, such as warrants, convertible debt or convertible preferred stock.

To calculate the dilutive effect of options, you use the Treasury Stock Method.
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?
Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all "in-the-money" -- their exercise price is less than the current share price.

When these options are exercised, there will be 10 new shares created -- so the share count is now 110 rather than 100.

However, that doesn't tell the whole story. In order to exercise the options, we had to "pay" the company $5 for each option (the exercise price).

As a result, it now has $50 inn additional cash, which it now uses to buy back 5 of the new shares we created.

So the fully diluted share count is 105, and the fully diluted equity value is $1,050.
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?
$1,000. In this case, the options' exercise price is above the current share price, so they have no dilutive effect.
Why do you subtract cash in the formula for Enterprise Value? Is that always accurate?
The "official" reason: Cash is subtracted because it's considered a non-operating asset and because Equity Value implicitly accounts for it.

Another way to think about it: In an acquisition, the buyer would "get" the cash of the seller, so it effectively pays less for the company based on how large its cash balance is. Remember, Enterprise Value tells us how much you'd really have to "pay" to acquire another company.

It's not always accurate because technically you should be subtracting only EXCESS cash - the amount of cash a company has above the minimum cash it requires to operate.
Is it always accurate to add Debt and Equity Value when calculating Enterprise Value?
In most cases, yes, because the terms of a debt agreement usually say that debt must be refinanced in an acquisition. And in most cases a buyer will pay off a seller's debt, so it is accurate to say that any debt "adds" to the purchase price.

However, there could always be exceptions where the buyer does NOT pay off the debt. These are rare, but "never say never" applies.
Could a company have a negative Enterprise Value? What would that mean?
Yes! It means that the company has an extremely large cash balance, or an extremely low market cap (or both). You see it with:

1. Companies on the brink of bankruptcy
2. Financial institutions, such as banks, that have large cash balances.
Could a company have a negative Equity Value? What would that mean?No. This is not possible because you cannot have a negative share count and you cannot have a negative share price.Why do we add Preferred Stock to get to Enterprise Value?Preferred Stock pays out a fixed dividend, and preferred stock holders also have a higher claim to a company's assets than equity investors do. As a result, it is seen as more similar to debt than common stock.How do you account for convertible bods in the Enterprise Value formula?If the convertible bonds are in-the-money, meaning that the conversion price of the bonds is below the current share price, then you count them as additional dilution to the Equity Value; if they're out-of-the money then you count the face value of the convertibles as part of the company's Debt.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?This gets confusing because of the different units involved. First, note that these convertible bonds are in-the-money because the company's share price is $100, but the conversion price is $50. So we count them as additional shares rather than debt. Next, we need to divide the value of the convertible bonds - $10 million - by the par value - $1,000 - to figure out how many individual bonds we get: $10 million / $1,000 = 10,000 convertible bonds. Next, we need to figure out how many shares this number represents. The umber of shares per bond is the par value divided by the conversion price: $1,000 / $50 = 20 shares per bond. So we have 200,000 new shares (20*10,000) created by the convertibles, giving us 1.2 million diluted shares outstanding. WE DO NOT USE THE TREASURY STOCK METHOD WITH CONVERTIBLES because the company is not "receiving" any cash from us.What is the difference between Equity Value and Shareholder's Equity?Equity Value is the MARKET VALUE and Shareholder's Equity is the BOOK VALUE. Equity Value can never be negative because shares outstanding and share prices can never be negative, whereas Shareholder's Equity could be any value. For healthy companies, Equity Value usually far exceeds Shareholder's Equity.