Enterprise Value vs Equity Value

Enterprise value and equity value are two terms used when discussing business valuations. Enterprise value (EV) is used when considering the purchase of a business, whereas equity value, which is often referred to as market value (MV), is used when considering an investment in the common stock of the business.

 

Enterprise Value

The net assets of a business are funded by a combination of debt and equity. It follows that the value placed on these net assets must be the same as the value placed on the equity plus the value placed on the debt.

Net assets value = Equity value + Debt value

The value of the net assets of the business can be split into operating and non-operating assets and liabilities. Operating net assets are those needed to operate the business such as accounts receivable, inventory, accounts payable, and property plant and equipment. Non-operating assets and liabilities such as cash and cash equivalents are those surplus to operational requirements.

If we assume that the value of debt is the same as its book value and that the only non-core asset or liability is cash, we can expand the formula as shown below.

Net operating assets value + Cash = Equity value + Debt

This is summarized in the digram below.

Net assets value
Net operating assets value (EV) Cash
Equity value (MV) Debt

The enterprise value (EV) is the term given to the value of the net operating assets of the business; substituting in the above equation we arrive at the enterprise value formula as follows.

Enterprise value = Equity value + Debt - Cash

The term net debt is often used to refer to the net difference between the debt and the cash balance and the formula can be rewritten as follows.

Enterprise value = Equity value + Net debt

It should be noted that the enterprise value can also be determined by calculating the value of each of the operating assets and liabilities of the business rather than using the market value of equity and the enterprise value formula.

Equity Value or Market Value

The equity value used in the above formula is the value placed on shares in the common stock of the business by an investor.

The equity value is calculated by multiplying the value of each share by the number of shares in issue.

For example, if a share is worth 15.00 and there are 15,000 shares in issue, then the equity value is calculated as follows.

Equity value = Share price x Number of shares in issue
Equity value = 15.00 x 15,000 = 225,000

The equity value is also referred to as the market value (MV) or market capitalization.

Debt Value

Debt primarily represents money lent to the business. For the purpose of the enterprise value formula calculation debt also includes other items such as, for example, minority interests, preferred equity, and any liabilities due under lease contracts.

Enterprise Value Example

The balance sheet of a business shows cash balances of 13,895 and debt of 46,764. The business has 15,000 shares in issue and the shares are currently valued at 15.00 per share.

The enterprise value formula is used as follows.

Equity value = Share price x Number of shares in issue
Equity value = 15.00 x 15,000 = 225,000
Enterprise value = Equity value + Debt value - Cash
Enterprise value = 225,000 + 46,764 - 13,895 = 257,869
Net assets value 271,754
Enterprise value (EV) 257,869 Cash 13,895
Equity 225,000 Debt 46,764

The value of the net operating assets of the business is the enterprise value 257,869. The enterprise value is the amount needed to acquire the business operation free of debt and excluding surplus cash balances.

The equity value of 225,000 is the amount investors would have to pay to acquire 100% of the common stock of the business which would include taking over the liability for the debt and receiving any surplus cash in the business.

Enterprise Value and Trading Multiples

Comparative trading multiples are often used to determine the valuation placed on a business.

The choice of multiple depends on the value required. If the enterprise value is required then the enterprise multiple is used. If the equity value is required then the price earnings multiple is used.

Enterprise Multiple

The enterprise multiple is calculated by dividing the enterprise value (EV) by the earnings before interest, taxes, depreciation and amortization (EBITDA).

Enterprise multiple = EV / EBITDA

It should be noted that since we are trying to calculate the enterprise value the earnings figure used is EBITDA which is the earnings generated by the net operating assets of the business available to both debt and equity stakeholders.

Price Earnings Multiple

The price earnings multiple or PE ratio is calculated by diving the equity value of the business by its net income.

PE Ratio = Equity value / Net income

The ratio is more often calculated on a per share basis.

PE Ratio = Price / EPS

Where price is the equity or market value per share and EPS is the earnings or net income per share.

In this case the net income is used as this represents the earnings which the equity holders are entitled to after the deduction of interest which is the amount due to the debt holders.

Summary

The enterprise value and the equity value are used to ascertain the value of a business under different circumstances.

The enterprise value is the value of the net operating assets of a business and is relevant for all stakeholders including debt holders and equity holders.

The enterprise multiple from a comparative business can be applied to the earnings generated by the operating assets (EBITDA) to arrive at an enterprise valuation for the business.

The benefit of the enterprise value is that it excludes the effect of the capital structure of the business enabling comparisons to be made.

The equity value is the value of the net assets of the business less the amount due to debt holders and represents the amount the equity holders are entitled to. The price earnings multiple can be applied to the net income of a business to arrive at an equity valuation.

Enterprise Value vs Equity Value November 14th, 2017Team

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