dcf valuation question
I have a question regarding valuation in a DCF model.
You can either value a company on it's levered or unlevered cash flows. ie. equity or enterprise value. Every valuation text I see shows the DCF model using unlevered cash flow (valuing at enterprise value).
When is it appropriate to value a company's equity and use levered cash flow for valuation? Do research analysts do this when they rate a stock buy/hold/sell? Why do all bankers use enterprise value in their DCF models vs equity value?
I would love if someone can clear this up for me. Thanks
I'll take a shot, but Im still in College so be aware:
Enterprise Value (EV) is the value of ALL the assets (aka, entire company) in a firm (owned by both shareholders and bondholders). equity value is the value of the assets that are owned by shareholders.
EV is used because when you're looking at a company, you essentially want to know what is the total cost to you, if you were to buy the WHOLE company, and not only the equity.
In other words, if you wanted to acquire 100% of a company, you would have to: 1. Buy all the equity (Equity Value), and 2. Pay-off the debt (Net Debt). Add 1+2, you get EV.
EV is also used because it values companies independent of their capital structures. This would give you a better apples-to-apples comparison when you are comparing 2 companies.
Thats it for me. I'm a bit too lazy to write anymore. Hope its all right.
I appreciate the responses, but my question is more along the lines of...who uses equity value in the actual real-world? I understand the difference, but I see valuing the equity very frequently mentioned in literature (mostly as an example like Mez just described)yet I am unsure when to use an equity valuation in practice.
Do Equity Research Analysts use DCF models using equity value's versus enterprise values?
DCF based on unlevered FCFs (Enterprise or firm value) values a company independent of its capital structure. Unlevered FCFs gives you the cash flows available to all capital holders (not just shareholders)
No one uses it unless you run a dividend discount model... The cost of the firm is based on its ability to generate cash flow... Debt can be refinanced immediately, ie an LBO and the equity valuation is therefore meaningless...
But from a research analysts perspective (recommending the stock of a company as buy/sell/hold to their traders or to the public) would they use equity valuation methods? Since they are only recommending the stock/equity at it's current capital structure, it seems as if equity valuation methodologies would drive their models.
It's just not practical to use the equity valuation method. Shit. Some places barely use the unlevered DCF approach. You're already making a ton of assumptions when building a DCF so why add another layer of assumptions by trying to guess how management is going to utilize debt over time. Use unlevered DCF and take out the net debt to come up with theoretical equity valuation.
I could see this coming in handy if you were a research analyst for a PE firm looking to compare two companies independent of their capital structures. Useing their unlevered cash flows would enable you to s build a comp saying, if we enacted a similar capital structure in our firm the market would value the company at...
bump
Not practical is exactly right (I smell irony).
its common sense, equity value is used only when deals around equity are taking place for example taking over of equity capital with or without debt. Otherwise it really does not make any difference. As the discount rate is combination of equity and debt cost it hardly matters and to calculate equity anyways the basis is EV so it really does not make a difference. I hope i am succeeding in confusing...
I think what the OP is asking is: If ER analysts use DCFs to back out a stock price, shouldn't they only be looking at equity value / levered FCF? i.e. they are only looking for what market cap should be based on future discounted cashflows? Not what an investor would have to pay for the entire company - enterprise value incl. debt, minority interest, pension ob's etc?
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