Enterprise value and equity value

Most likely, my question is stupid and trivial, yet has caused confusion.

As far as I know, Enterprise value = equity value + Debt + Preferred stock + minority interest - Cash and cash equivalents

Net debt = Debt - Cash and cash equivalents

To rewrite the formula for the enterprise value: Enterprise value = Equity Value + Net debt + Preferred stock + Minority Interest

I can't understand why some sources state that Enterprise value equals equity value plus net debt. I guess it's only true assuming that preferred stock and minority interest is zero (as well as some other items that are not accounted in this simplified formula).

Rosenbaum and Pearl also subtract net debt from enterprise value to get equity value (to be fair there's a footnote saying that net debt often is often considered to include any obligations senior to common equity).
That phrase doesn't clarify it very much.

Can you please explain the issue?

 

Started going over this stuff recently myself, but my understanding is that you subtract NIBLs (net interest bearing liabilities) from enterprise value to get equity value because when you buy a company you're buying the equity...but perhaps I'm wrong. FYI, here I'm using 'Financial Statement Analysis - Valuation, Credit Analysis and Performance Evaluation' by Petersen, Plenborg and Kinserdal Chapter 9

 
Best Response

There is no issue here. Your understanding is correct and it's really only a matter of detail. However, if I asked you in an interview what enterprise value means, and you answered "equity value plus net debt plus mi plus preferred stock plus capital leases plus excess pension liabilities minus equity interests minus NOLs," I'd only give you like 20% credit.

Spend more time worrying about conceptually what enterprise value actually means (i.e. the value of the operating assets based on the value of all the claims on the cash flows from those operatiing assets) than any single formula. Once you have that nailed down, the formula should make sense intuitively

 

Okay, thank you for the explanation. Actually, I'm trying to see the forest, but after having seen the same formula treated so differently, I started to doubt.

The same happened when I couldn't understand why the unlevered beta (asset beta) is calculated either with the (1-t) multiple or without it and why it looks the way it does. Turned out that the derivation is pretty easy, while the tax shield is optional according to Damodaran.

 

EV up $100. No change in Equity value. When you raise the $50 debt you’re adding offsetting amounts of debt and cash, so no change in EV yet. Then you would buy the asset causing cash to go down $100 and EV to go up $100.

 

The interviewer told me the answer is an increase in 150$ of EV (I answered $100 using the same logic as you @les Grossman)

Does this make sense?

Original EV - $1000 Debt - $0 Cash - $50 EqV - $1050

Raising $50 of debt Debt - $50 Cash - $100 EqV - $1050

Buying the $100 core asset Debt - $50 Cash - $0 EqV - $1050 EV = 1050 + 50 (net Debt) + 100 (core asset) = $1200

Hence EV up by $150

Is this right? Just finding it hard to visualize and understand, and ofc afraid I'll mess it up during interviews

 

EV should increase by $100. Equity value should be unchanged.

This is a simple way to think of it without the formula: conceptually, EV is the value of the operating assets of a company. Cash is not an operating asset. So if you just bought $100 of operating assets, your EV just went up by $100.

In the formula, cash goes down by $50 and debt goes up by $50. These offset each other, so equity value is unchanged.

 

Its +$100.

  1. When you raise $50 of debt, EV and FV stay the same because $50 debt is cancelled by $50 in cash.

  2. When you use that $50 to buy an operating asset, you don't subtract $50 when going from EV to FV because that cash is now an operating asset. You don't add the operating asset on top again. Like hominem said, your interviewer is double counting.

 

If I'm understanding your question, the public company would more than likely pay off whatever debt the private company had, if for no other reason than larger public companies can generally borrow more cheaply, not to mention any change in control provisions on the private company's debt. So the answer is the enterprise value. The public company might issue new debt to finance the transaction, use cash on the balance sheet, but that's not going to drive the fact the debtholders of the private company will probably want to get paid, and the public company will probably want to pay them to go away.

Life, liberty and the pursuit of Starwood Points
 

Everything else equal, if you minimize WACC, you'll be discounting free cash flows at the lowest rate, and hence you'll get the highest EV.

Yes they are the same, because the higher the EV the higher the share price after deducting net debt.

 

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