Market Cap vs. Firm Value vs. Enterprise Value?
What are the differences between these 3 values? Which one do I pay if I want to acquire a company?
Which value does FCFE valuation give?
Which value does FCFF valuation give?
Thanks in advance.
Equity vs. Enterprise Value for Acquisitions
Usually in an acquisition scenario, press will publish both the equity and enterprise value price for the company. When you purchase the entirety of a company - you are assuming both the debt and equity of the business. The liabilities of the old company are now your liabilities so that is an inherent cost of buying the business. With that in mind - you can accurately say that the enterprise value is what you are paying when you acquire a company. It is the most accurate representation of the cost of the business.
Difference Between Firm Value and Enterprise Value
While firm value is an ambiguous term, it is likely that firm value is synonymous with enterprise value.
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 aimed at a buyer.
The calculation for Enterprise Value is:
- Market Capitalization + Debt + Minority Interest + Preferred Shares – Cash & Cash Equivalents
Enterprise Value is a far better metric when considering mergers and acquisitions as it provides a 'truer' valuation of a company by considering more factors than market capitalization, the main one being debt.
Unlevered Free Cash Flow and Enterprise Value
Typically when someone is refering to free cash flow, they are refering to unlevered free cash flow which is the cash flow available to all investors, both debt and equity. When performing a discounted cash flow with unlevered free cash flow - you will calculate the enterprise value.
Free cash flow is calculated as EBIT (or operating income) * (1 - tax rate) + Depreciation + Amortization - change in net working capital - capital expenditures.
Levered Free Cash Flow and Equity Value
While unlevered free cash flow looks at the funds that are available to all investors, levered free cash flow looks for the cash flow that is available to just equity investors. It is also thought of as cash flow after a firm has met its financial obligations. When performing a discounted cash flow with levered free cash flow - you will calculate the equity value.
Levered free cash flow is calculated as Net Income (which already captures interest expense) + Depreciation + Amortization - change in net working capital - capital expneditures - mandatory debt payments.
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