Enterprise Value Less Than Equity Value

Assume that all we know about a fictional company is below:

Market cap = 100
Debt=0
Short-term securities=50

Therefore...equity value = 150, EV = 50

How could it ever be the case that Equity value and EV differ like this? What am I misunderstanding?

How Can EV be Smaller than Equity Value?

Yes - EV can be less than equity value if net debt is negative. Net debt is calculated as total debt minus cash. If your cash balance is larger than the debt of the business, preferred shares and minority interest of the company combined then you will have an EV smaller than your equity value. This is not uncommon for profitable businesses without debt.

What is Enterprise Value?

Enterprise Value (also known as EV) is a metric that attempts to reflect the market value of a firm. It can be used as an alternative to market capitalization.

Essentially, enterprise value attempts to provide a more accurate valuation for a buyer. While a firm's market capitalization will indicate share price x share quantity, the firm may have a lot of debt which the acquirer would need to pay off (thereby adding the price of the transaction).

The calculation for enterprise value is: Market Capitalization + Debt + Minority Interest + Preferred Shares – Cash & Cash Equivalents

What is Equity Value?

Equity value is another term for market capitalization and can be calculated as share price x shares outstanding.

How to Get From Enterprise Value to Equity Value?

Enterprise value + cash & cash equivalents - debt - minority interest - preferred shares will equal equity value.

Preparing for Investment Banking Interviews?

The WSO investment banking interview course is designed by countless professionals with real world experience, tailored to people aspiring to break into the industry. This guide will help you learn how to answer these questions and many, many more.

Investment Banking Interview Course Here

Comments (20)

 
Oct 6, 2012 - 3:10pm

MD8:
In your example, equity value is 100, not 150. Enterprise value is 50.

Enterprise value is less than equity value when net debt is negative. In your example, cash > debt, thus the decrease in enterprise value. Not at all uncommon, especially for companies that do not use leverage.

But then you are saying the equity value is less than the cash on the balance sheet?

 
Oct 6, 2012 - 3:43pm

couchy:
MD8:
In your example, equity value is 100, not 150. Enterprise value is 50.

Enterprise value is less than equity value when net debt is negative. In your example, cash > debt, thus the decrease in enterprise value. Not at all uncommon, especially for companies that do not use leverage.

But then you are saying the equity value is less than the cash on the balance sheet?


Market cap is equity value.

Market cap = equity value = $100 in your example
Enterprise value = market cap (equity) plus net debt = 100 + (0 debt - 50 cash) = 50 EV

EV is the value you would need to pay to acquire the business, net of cash / debt (and excluding control premia, etc.)

 
Oct 6, 2012 - 5:07pm

couchy:
MD8:
In your example, equity value is 100, not 150. Enterprise value is 50.

Enterprise value is less than equity value when net debt is negative. In your example, cash > debt, thus the decrease in enterprise value. Not at all uncommon, especially for companies that do not use leverage.

But then you are saying the equity value is less than the cash on the balance sheet?

It has $50 in cash, equity value is $100. Last I checked 100 > 50....

 
Oct 7, 2012 - 3:18am

If I was a buyer and a company had $100 worth of shares and a portfolio of short term securities worth $50 I just don't understand theoretically why I would pay less than $150 for this. I also don't understand why the short-term securities would reduce the price we pay for equity i.e. EV = 100 - 50

 
Oct 7, 2012 - 7:14am

The short-term securities don't reduce the price you pay for equity. You stated the company has $100 of shares - thus, you would pay $100 for the shares.

Let's say you borrow $100 to buy all the shares - you now own the company, which means you own the $50 of cash as well. You now use that cash to repay part of the $100 you borrowed, so in the end, you only really needed to borrow $50 to buy the business. Which means the business is actually worth $50 - this is the enterprise value (EV).

 
Oct 7, 2012 - 8:39am

you don't seem to understand the concept of market cap and what it represents.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
Oct 7, 2012 - 2:06pm

Ok I think the best way to figure this out is to again come back to the fictional company-this should nail it. Ok so:

Market cap = 100
Debt = 0
short-term securities = 50

D+E = 100 therefore A = 100 therefore to acquire all of the company's assets we should pay 100 ... But EV = Market cap + debt - short-term securities = 100 + 0 - 50.. So poof the 50 of non-operating assets disappears into thin air and instead of paying for all of the company's 100 of assets we now just pay 50 and we get a portfolio of short-term securities for free. There was no debt to pay down so where did the 50 of non-operating assets go?

 
Oct 7, 2012 - 2:08pm

equity value technically can be negative - if intrinsic EV is less than net debt. Practically speaking, this means equity value is zero, because "negative" is a bit misleading - sounds like it assumes some cash outflow which it normally doesn't.

EV technically can be negative as well - say the company has deeply negative EBITDA with no prospect of turnaround and no valuable assets to sell - so whatever metrics or method you apply - EBITDA multiple, P/E, DCF, you end up with negative EV. Fair enough that company that generates only losses on operational level costs nothing - it is cheaper to shut the company down immediately.

 
Oct 7, 2012 - 2:09pm

You don't have a clue what you are talking about, this isn't about valuation and multiples..

1) equity value cant be negative since share prices can't go below zero..
2) EV can go negative. Imagine a company that has nothing but 1 million dollar in cash. It can do nothing with that cash but to distribute that cash to its shareholders. However, when it would distribute the cash, the company has to pay 25% tax on that cash. Therefore, the shareholders would only think the company is worth 0.75 million for them and EV would be negative.

 
Oct 7, 2012 - 2:16pm
Start Discussion

Total Avg Compensation

November 2020 Investment Banking

  • Director/MD (18) $713
  • Vice President (51) $332
  • Associates (271) $228
  • 3rd+ Year Analyst (39) $161
  • 2nd Year Analyst (152) $153
  • Intern/Summer Associate (139) $139
  • 1st Year Analyst (592) $130
  • Intern/Summer Analyst (565) $82

Leaderboard See all

1
LonLonMilk's picture
LonLonMilk
98.4
2
Jamoldo's picture
Jamoldo
98.3
3
Secyh62's picture
Secyh62
98.2
4
CompBanker's picture
CompBanker
97.9
5
redever's picture
redever
97.8
6
frgna's picture
frgna
97.5
7
bolo up's picture
bolo up
97.5
8
NuckFuts's picture
NuckFuts
97.5
9
Addinator's picture
Addinator
97.5
10
Edifice's picture
Edifice
97.5