Market Cap vs. Firm Value vs. Enterprise Value?

Hello,

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.

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

WSO Elite Modeling Package

  • 6 courses to mastery: Excel, Financial Statement, LBO, M&A, Valuation and DCF
  • Elite instructors from top BB investment banks and private equity megafunds
  • Includes Company DB + Video Library Access (1 year)

Comments (12)

Dec 28, 2014 - 3:10pm

Market cap= total value of all outstanding common equity securities. Enterprise Value is market cap + net debt (debt minus cash). If you are acquiring a company in full, you would be paying the Enterprise Value as you are assuming their debt load as well.

Dec 29, 2014 - 9:16am

cheese86:

Market cap= total value of all outstanding common equity securities. Enterprise Value is market cap + net debt (debt minus cash). If you are acquiring a company in full, you would be paying the Enterprise Value as you are assuming their debt load as well.


Thanks for the answer. But I didn't get the last part. If I want to buy a company, I think I should pay the market cap.

Price x shares outstanding = market cap

If I buy all shares, I'll own the company. Isn't that right? :/

Dec 29, 2014 - 9:20am

fa1313:

cheese86:

Market cap= total value of all outstanding common equity securities. Enterprise Value is market cap + net debt (debt minus cash). If you are acquiring a company in full, you would be paying the Enterprise Value as you are assuming their debt load as well.

Thanks for the answer. But I didn't get the last part. If I want to buy a company, I think I should pay the market cap.

Price x shares outstanding = market cap

If I buy all shares, I'll own the company. Isn't that right? :/

sure...but what happens to the company's debt then? who assumes it after you've bought over 100% of the equity?

Dec 29, 2014 - 10:34am

cheese86:

Market cap= total value of all outstanding common equity securities. Enterprise Value is market cap + net debt (debt minus cash). If you are acquiring a company in full, you would be paying the Enterprise Value as you are assuming their debt load as well.

NO - this is incorrect

if you are acquiring the enterprise value you are acquiring the business on a cash free, debt free basis. Most private M&A buyers are acquiring enterprise value. For example, if $150M in EV, buyer is paying $150M, and the seller gets to keep the cash and pay off the debt. If there is $100M of debt on the business, seller nets $50M.

In public M&A, buyers are acquiring the equity value (i.e. they are assuming the cash and debt). Shareholders look at price per share when they consider to vote yes or no for a merger so buyers need to express their bids in terms of price per share, which is equity value

In short, if you are acquiring enterprise value you are not assuming cash/debt (seller keeps), if you are acquiring equity value buyer assumes all cash and debt

Learn More

300+ video lessons across 6 modeling courses taught by elite practitioners at the top investment banks and private equity funds -- Excel Modeling -- Financial Statement Modeling -- M&A Modeling -- LBO Modeling -- DCF and Valuation Modeling -- ALL INCLUDED + 2 Huge Bonuses.

Learn more
Dec 29, 2014 - 12:00pm

OK fiji-so on a net basis you are saying the same thing. But, since you obviously are proud to have passed Finance 101 and are telling me that I'm wrong (when in fact I'm not), I'll add a wrinkle here-the seller does not necessarily keep the cash and pay off the debt in private M&A-the acquirer will often "credit enhance" old debt and leave it outstanding until it can be taken out at a reasonable level after the make-whole period. If the debt is going to trade through the typical 101 change of control put, the debt holders at the acquired entity will prefer to remain outstanding and the company will often leave them outstanding until they can be called cheaper.

Dec 28, 2014 - 3:26pm

FCFF is the cash available to all debt & equity investors in the firm. FCFE is the cash available to shareholders after all expenses, reinvestment and debt repayments. FCFE = FCFF - [Interest x (1-Tax Rate)] + Net Borrowing

Dec 30, 2014 - 5:18am

You guys are making this shit too complicated. The point is you want to be able to have a way of looking at a business or potential acquisition in a way that isnt biased by the current capital structure, so you can freely use one metric to compare across different businesses. That is enterprise value - the value of the business operations, Debt + Equity - Assets not needed to run the business.

Firm value does not subtract excess assets, otherwise it is the same as Enterprise value. So unlike EV, firm value is affected by items such as excess cash or securities when comparing two different firms.

When looking at an acquisition you want to look at enterprise value regardless of the situation. Even if you are acquiring a public target and assuming debt, and your offer is in dollars per share, for your own sake you want to know what price you are actually paying for the entire business. Because you could have another target with no debt; if you compared the two targets just looking at the price you are paying for equity, the second may appear much higher priced even if in reality you are paying the same price for both businesses. Assumed debt has a real economic cost. Likewise excess cash and assets can be liquidated and have a real economic benefit.

Best Response
Dec 30, 2014 - 10:21am

Another way of thinking about enterprise value vs market value (which should give you the same result as the technical, formula based calc) follows.

Enterprise value is the value of the "enterprise" ie the business. If you're valuing the business, you don't care how the business is funded ie a business that makes 100 widgets a day for $10 each and sells them at $20 should be valued the same as a business, regardless of whether it's 100% equity funded or 1% equity funded, 99% debt funded. Under either funding structuring, the business represents the same cash flow (free cash flow to the business (aka free cash flow to the firm ie FCFF)) before that cash flow is then allocated between equity (free cash flow to equity ie FCFE) and debt funders.

As an incoming buyer, you're focused on the enterprise value as that represents what you're getting at the end of the deal - an enterprise that you hope will generate a flow of future cash.

equity value is the value of equity's share of the business and the cash flow it generates. That is, free cash flow to equity is equity's share of free cash flow to the firm. Following that logic:

  • You take the value of the business (enterprise value)
  • You subtract the value of net debt* (which represents debt's share/claim over the value of the business)
  • If there are preference shares in the structure, you subtract their value as well (as you're looking to get to market value of ordinary equity, which ranks behind preference shareholders' claims over the value of the enterprise)

That leaves you with the value of equity's claim over the value of the enterprise ie the equity value.

* Net debt = total value of debt less cash. My view is that cash needed in the business for working capital is part of the enterprise, so should not be subtracted from debt. However, a lot of people subtract total cash.

For a listed company, the equity value should equate to the market value. For listed companies, you apply the approach above in reverse ie you take market value of shares, add the value of net debt plus preference shares and you then get the implied enterprise value.

A buyer will typically calculate the enterprise value for the company first and focus on that valuation. The buyer's bid will be based on that enterprise valuation ie you'll hear people refer to "bidding 8 times for the target" ie paying an enterprise value of 8x EBITDA.

What that means is:

  • 8x EBITDA is the total price paid to ALL funders of the business
  • Typically, part of the 8x amount is first paid to clear out existing debt (ie paying out debt's claim on the 8x EBITDA enterprise value)
  • The remaining part of the 8x is then paid to the owners of the company (ie paying out equity's claim on the 8x EBITDA enterprise value)

So, if the business is, say, 3.0x levered under the existing capital structure, debt gets paid out 3.0x EBITDA (ie face value of their debt plus any outstanding interest) and equity gets 5.0x EBITDA.

A buyer will fund its 8.0x EBITDA purchase price independent of the existing capital structure. For example, a PE fund may do an LBO buy out of the company, funding the deal with 4.0x first lien senior debt, 1.5x second lien debt (ranks junior to the first lien) and 2.5x equity funding (ie the PE fund's own money put into the business).

From the above, you can see market price of equity (in a listed company takeover) is a secondary consideration ie the by-product of calculating the enterprise value of the target. While a bidding war may make everyone focus on the offer price for the shares, a bidder should always be calculating the maximum offer price it will offer with reference to its enterprise value calculations.

While there is a lot of psychology and gaming around the bid price actually offered, the maximum price is a by-product of the enterprise value calculation, because how the business is funded today is irrelevant to the value the business will provide to the new owner (ie the enterprise value).

Those who can, do. Those who can't, post threads about how to do it on WSO.
  • 7
Start Discussion

Total Avg Compensation

July 2021 Investment Banking

  • Director/MD (10) $853
  • Vice President (36) $363
  • Associates (210) $232
  • 2nd Year Analyst (121) $152
  • 3rd+ Year Analyst (28) $146
  • Intern/Summer Associate (102) $144
  • 1st Year Analyst (449) $132
  • Intern/Summer Analyst (357) $82