Enterprise Value vs Equity Value

A company may be appraised using enterprise and equity value(the net asset value) in a merger or acquisition. Both may be employed in a company's assessment or sale, but each presents a somewhat different perspective. 

Enterprise value represents the company's value attributable to all investors, while equity value represents a portion available to shareholders.

Equity value is the number the public at large sees. It comprises the company's value of loans and shares of owners and shareholders who have invested in the business (attributing equity investors). It gives the precise estimation of current and latent future value. 

The Enterprise Value (EV), also known as Firm Value, comprises more than just the dominant Net Asset Value. As the name implies, EV is the total value of a company in monetary terms. It results in a calculation of shareholders and the debt holders, attributing all investors (debt, Equity, preference, etc.).

The Valuation of a business using unlevered free cash flow (UFCF) in a DCF model would be commensurate with the calculation of EV. It helps compare firms with divergent capital structures and reveals how much a business is worth. 

Enterprise Value (EV)

Enterprise Value, also known as Firm Value, is an equation that calibrates a company's performance. It is useful in comparing firms with different capital structures, which does not influence the firm's value. It represents the true value of the company defined in terms of financing.

It shows the amount needed to acquire another company. Another perception is that if a company's total cash and cash equivalent value exceeds the combined total of its market capitalization and debts, the EV would appear negative.

This implies that a company is not using too much cash. The extra cash can be used for many things that could profit the company.

For instance: Expansion of business, considering eliminating debts, establishing cash reserves, etc.

Since EV ignores the capital structure of the company, EBITDA 

(EBITDA= Net Income + Interest + Taxes Paid + Depreciation & Amortization) 

It happens to be its best value driver, as it removes the effects of differences in capital structure since the capital structure doesn't affect the firm's value.

A common multiple used in relative value comparisons is Enterprise Value to EBITDA, commonly known as EV/EBITDA. Other common EV multiples include EV/EBIT, EV/Revenue, and EV/EBITDAR.

Similar to this, there is P/E ( Price to earnings), also known as Price or earnings multiple. This multiple indicates the company's growth potential on the current market price basis. But this metric is only useful when the companies are in the same industry or field.

Calculation of EV

Businesses use EV to measure the cost of acquiring an establishment or business because it accounts for more than its outstanding shares by adding debt and subtracting cash from the cost. Here's how EV is calculated:

Few circumspect EVs as it involves total debt; one must contemplate how a company operates this debt.

EV is a measure of the entire market value of a firm. It is calculated by considering the company's Market Capitalization, adding debt, minority interests, and preferred stock, and then subtracting cash & cash equivalents.

EV = Market Capitalization + Debt + Minority Interest + Preferred Shares - Cash & Cash Equivalents

The formula above might seem hard to remember. So here's a simpler way:

EV = MC + Total debt - C

Where, 

MC = Market Capitalization; equal to current stock price multiplied by the number of outstanding stock shares.

Total debt = The sum of short and long-term debts/liabilities

C = cash & cash equivalents, a company's liquid assets.

Simply put, Enterprise value (also known as Firm Value or Asset value) is the total value of assets of the business (excluding cash). Learn more on EV multiple here.

Various EV Valuation Multiples

EV is considered a better valuation metric for M&A than market cap, as it includes the debt the acquirer will have to bear, and the cash received. The multiple varies depending on the type of industry. 

A firm may have high levels of debt and preference share; such firms are deemed to be risky.

Investors use a company's multiple to figure out whether a company is undervalued or overvalued to make better resolutions. 

In addition, an enterprise multiple is helpful in differentiation internationally as it disregards the misinterpreting effect of individual countries' taxation policies.

Enterprise multiples may vary, subject to the type of industry. For example, one might expect high enterprise value in high-growth industries and vice versa.

1. EV/EBITDA

This valuation multiple is calculated as EV divided by EBITDA. It is the most common and widely used valuation multiple that involves EVs.

This metric allows investors to compare and contrast returns from comparable companies. 

Using EBITDA as a metric for analysis offers investors the opportunity to perceive earnings unaffected by debt costs, depreciation, and amortization expenses.  

2. EV/EBIT

It is calculated as enterprise value divided by earnings before interest and taxes. 

EBIT is similar to EBITDA except for excluding depreciation and amortization. This ratio can be great for analyzing whether Equity is overvalued or undervalued. 

3. EV/Revenue

This valuation multiple is calculated as EV divided by revenue. 

As it ignores profitability and the generation of cash flow, the results may be difficult to interpret.

It can increase difficulty in comparing across companies because different businesses have different revenue recognition philosophies, which can lead to overblown or underperforming sales numbers.

EV/Revenue is a fantastic valuation multiple for companies in their early stages. Early-stage growth companies are often unprofitable or breaking even. Because of this dynamic, EV/EBITDA cannot be used as there are no earnings to account for. 

4. EV/EBITDAR

This valuation multiple includes EBITDAR, which stands for earnings before interest, taxes, depreciation, amortization, and rental costs/restructuring costs. This multiple is calculated by taking EV and dividing it by EBITDAR. 

This is a great multiple for comparing companies within the hospitality, transportation, or restaurant industries. Companies within these industries often have high rental costs, which need to be accounted for. 

EBITDAR can be a great multiple for comparing companies that have recently incurred many restructuring costs.

Significance of Enterprise Value

Enterprise Value is considered to represent a firm's value accurately. It is the value of the company's assets related to its core business operations to all investors (including Equity, debt, preferred, and potential noncontrolling interests). At the same time, equity value is attributable to equity investors.

The value using unlevered free cash flow in DCF modeling is EV. It can be seen as an estimation of the possible expense of purchasing a company. If there is a phase of Mergers & Acquisitions, EV discloses the value of a company to be acquired or invested by another company. 

Investors use it to nullify the risks and compare the expected returns. It also helps investors make rational decisions considering market capitalization and a company's debt and cash position. In such a case, an EV/EBITDA multiple below ten is considered healthy as it displays the total value of actual earnings.

Rundown to Significance of EV:

• Gives us an indication of a company's worth.
• Helps in valuing businesses and compares companies with different capital structures.
• Investors can determine the size of a company, along with factoring in how the business has used its debt.
• Represents the economic value of the company.

Equity Value

It is the value of a company's shares and loans that the owners or shareholders have invested in the business. In a nutshell, it's the total value of the company that is attributed to equity investors. It calculates the Enterprise value plus all Cash & Cash equivalents, short & long-term investments, and minority interests.

The main purpose is to estimate the value of a firm or securities. Stock investors and stock market participants use Equity Valuation to make investment decisions in the Equity market. Shareholder's Equity is the value of a company's obligation to shareholders.

It enables companies with sound business models to have leverage in the market. It also ensures companies with weak fundamentals observe a drop in their Valuation. It enables the current economy to allot scarce capital resources among several other participants expertly.

It's the value of all company assets, but only to equity investors ( i.e., Common shareholders ).

It offers a conception of potential future value and growth potential. The value may vary on any day due to the unpredictable stock market. The value is determined when the company evaluates using a levered free cash flow (LFCF) in a DCF Model (Discounted Cash Flow).

You might need clarification as Equity Value and Market cap sound similar. A company's market capitalization measures the value of its common Equity as the latest market cap. It is always confusing and interchanged with the term "equity value." 

Important attention to differentiate Equity value(or the Net Asset Value) and market capitalization is that the net asset value consolidates all equity interest in a firm. In contrast, market capitalization only reflects currently outstanding common shares.

Calculation of Equity Value

The overall value of a company that may be attributed to its shareholders is known as equity value. There are several ways to perform equity valuation. The valuation models include DCF, asset-based approach, book value approach, and many more.

Before you start with the calculations, remember a few things. It is the most challenging part. Valuation should broadly account for these parameters as pre-defined standards for accurate results:

• Understand the macroeconomic factors and the industry.
• Forecast the company's performance.
• Consider the appropriate valuation method/model.
• Arrive at the Valuation based on forecasting.
• Initiate action based on arrived Valuation.

Here's how Equity Value is calculated:

Equity value = Price per share x fully diluted shares outstanding

(Or)

Equity value = EV - (total debt + cash)

Equity value comes in two forms:

• Basic equity value 
• Diluted equity value.

The only difference is the number used for outstanding shares. Diluted shares outstanding are shares outstanding, including any diluted from options, convertible bonds, etc.

The Net Asset Value can be calculated in two ways: through the intrinsic value method or the fair market value method. The fair market value method more accurately captures the value of out-of-the-money securities.

Learn more on Equity Value from here.

Simple Analogy to Understand the Difference between Enterprise Value and Equity Value

Let us say you want to invest in a company worth 5 million dollars. The company's worth remains the same regardless of whether the company has more liquid assets (cash equivalents) and less debt and the net asset value or contrariwise. Or acquire a company to expand your business.

The company's worth sets out the concept of EV. While determining/calculating EV, you acknowledge that the company might have huge debt or excess cash in the business, which will help you make better decisions about whether to buy and sell securities of that company if you already possess them. Or acknowledge that the company is risky to invest in.

Suppose you are certain that a company has a healthy EV (certain that it is neither under nor over-valued). In that case, you can analyze its net asset value to consider if it's a good investment with good returns. Consequently, invest in the market.

The debt and equity proportion variance do not influence a company's performance or worth. Over time, the company may be free of its debts, and the net asset value would increase, showing Equity/Ownership value in positive figures.

Calculation of Enterprise Value and Enterprise Value with an Example.

When an investor buys a company, he/she needs to pay not only the common shares but the individual/person has to pay the shareholders of preferred stock. He also assumes the company's debt and receives the cash on the company's balance sheet. As the responsibility of the company lies on working capital.

After the acquisition of a company, The investor can pay less than the market cap if the company has excess cash than debt, as he owns the cash immediately after settling the transaction/ agreement. So he doesn't risk his business.

The EV will be negative if the company's net cash exceeds its market cap. In short, the investor is getting the company for free and paying for that.

Calculations are based on an existing company for a better understanding of the concept.

Alphabet Inc is a holding company with Google, the internet media giant, as a wholly owned subsidiary. It is one of the big 5 American Information Technology companies, alongside Amazon, Apple, Meta, and Microsoft.

*The exercise is done concerning Alphabets' Balance sheet for 2021. It is empirically explained the Difference in both Valuations.

Alphabet's (Google) Enterprise Value for the fiscal year that ended in Dec. 2021 is calculated as 

Enterprise Value (A: Dec. 2021)

= Market Cap + Preferred stock + Long-Term Debt & Capital Lease Obligations

= 1,915,910.432 + 0 + 26,206

+ Short-Term Debt & Capital Lease Obligations + Minority Interest - Cash Equivalent Marketable securities

+ 2,189 + 0 - 139,649 = 1,804,656

Alphabet (Google) 's Equity Value for the fiscal year that ended in Dec. 2021 is calculated as

Common Equity (market value) = Share price × No. of shares of common stock outstanding

= 99.71 × 13,044,000,000

= 1,300,617,240,000

*All numbers are in millions except for per-share data, ratio, and percentage. All currency-related amounts are in USD and indicated in the company's associated stock exchange currency.

Understanding concepts in debt

We understand that individuals come from different backgrounds, professional experiences, and expertise. However, to understand a company's enterprise and net asset value, you must understand each part of the equation. Here are a few concepts to understand in debt.

1. Market Cap: 

It is the short form for market capitalization. This metric is calculated by multiplying the outstanding shares by the current share price. Bear in mind that the term is interchangeable with "equity value."

This number can fluctuate as share prices go up or down and as the number of outstanding shares changes based upon various corporate actions, such as new issues via secondary offerings, share buybacks, and employees of a company exercising their stock options. 

2. Debt:

It is the money lent to a company by a lender that requires interest payments to be made. Within the EV formula, debt is calculated by adding short-term debt and long-term debt together. 

The more debt a company holds, the higher the EV will be. Likewise, the less debt a company holds, the lower the EV will be. 

If an analyst cannot identify the market value of a company's debt, they can use the book value of a company's debt as an alternative.

3. Minority Interest: 

It represents a noncontrolling interest in another company. For ownership to classify as a minority interest, the ownership must be less than 50% of the total available ownership of a company.

Minority interest within the EV formula accounts for the value of the small shareholders who have no control over the company. Generally, It is the portion of a subsidiary company's stock that the parent company does not own. 

Therefore, it is found in the non-current liability or equity section of the parent company's balance sheet under GAAP.

By including this measure within the EV calculation, we can come to a more accurate conclusion on the true value of a firm. It is a comparison of similar things, such as a company's EV, to numbers of terms such as total sales, EBIT, or EBITDA.

4. Preferred Shares:

These are equities with special benefits such as dividend payments and a higher rank in the liquidation process if a company is dissolved. 

These types of shares offer the benefits you would get from holding common stock (through a share in dividends) and from holding a fixed-income security (higher rank than Equity). 

5. Cash and Cash Equivalents: 

These include short-term financial instruments on top of already available cash. These short-term financial instruments are highly liquid money market instruments that can easily and quickly convert into cash. Cash Equivalents include marketable securities, commercial paper, certificates of deposits, repo agreements, and treasury bills. 

Important Considerations

The value still available to shareholders after all debts have been settled is the equity value (also known as net asset value). A company's enterprise value is its overall asset value, often known as firm value or asset value (excluding cash).  

While the Equity Value attributes to Equity investors, the Enterprise Value attributes to all investors. Therefore, equity value is a portion of EV.

As we come to the end of this article, to help you remember the concept in the near future, Below are some of the important considerations to keep in mind.

1. EV: The value of the company's assets related to its core business operations but to all investors ( including Equity, debt, preferred, and potential non - controlling interests).

2. Equity Value (The Net Asset Value): The Value of all company assets, but only to equity investors (i.e., Common shareholders). 

3. EV and Net Asset Value concepts are based on the premise that value from a company is calculated from the present value of the future Cash flows.

4. No matter how a company is financed, EVs remain the same. Net Asset Value, however, may change depending on the mix of Equity Vs. Debt Vs. Cash.

5. Although Net Asset Value is one of the most commonly quoted numbers when talking about the value of a company, it is not that useful as enterprise value reflects a far truer value. 

6. Investors consider these valuations to make better decisions as to whether to invest in a company and watch out for any fraudulent act or risk themselves.

7. EV is also known as a firm value, and The Net Asset Value is the same as the Shareholders' Value.

Researched and authorized by Hajira Khan | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Absolute Valuation
• APV (Adjusted Present Value)
• Art Valuation
• Assessed Value
• Ballpark Figure