## Equity Value and Enterprise Value: The First, Last, and Only Guide You’ll Need to Master These Concepts

Is there a topic that *everyone* is wrong about?

You might think of many examples if you limit yourself to politics and religion, but “mass wrongness” also extends into **technical questions** in investment banking interviews.

Some sources have spotty coverage of accounting, valuation, and M&A analysis, but no one is completely wrong about those topics.

But it’s a different story with **Equity Value and Enterprise Value**.

If I were giving a rigorous technical test to IB/PE interview candidates, I would base 100% of my questions on these concepts.

Why?

Because there are *so many* terrible explanations that questions based on Equity Value and Enterprise Value are a great way to find the best candidates:

**Your Free 94-Page Guide to Equity Value and Enterprise Value**

I’ll avoid a lengthy preamble here and give you what you’re looking for below:

- Equity Value, Enterprise Value, and Valuation Multiples – Written Guide (PDF)
- Excel Examples for Equity Value and Enterprise Value

If that’s too long, you can get the summary version below:

**The Real Definitions of Equity Value and Enterprise Value**

Both of these terms relate to a **company’s** **value**.

You can estimate “company value” with this formula:

**Company Value** = Cash Flow / (Discount Rate – Cash Flow Growth Rate)

It’s the same formula used for Terminal Value in a DCF; in real life, we have to create a DCF instead of using this single formula because a company’s Growth Rate, Discount Rate, and Cash Flow *change* over time.

A company with higher Cash Flow is worth more than one with lower Cash Flow.

A company with higher Cash Flow Growth is also worth more.

And a company is also worth more if the Discount Rate is lower, i.e. *you are targeting lower returns*.

For simple, back-of-the-envelope calculations, this formula is a good way to estimate the value of an asset or company.

But past a certain point, **you must be more specific about what “Company Value” means.**

For example, does it refer to what *the market as a whole* believes a company is worth?

Or does it refer to *our opinion *of what the company is worth?

And does “Company Value” include all the company’s Assets or just those related to its core business?

Finally, does “Company Value” mean “value to *all* investors,” or just to *certain* investors?

Because of the first issue – the market’s views vs. our own – we split “Company Value” into Current Value and Implied Value:

**Current Value:**What “the market as a whole” believes the company is worth. If the company is public, its share price reflects this amount. If the company is private, silly venture capitalists pouring money into a Ponzi scheme (Uber) reflect this amount.**Implied Value:**What*you*believe the company is worth. This figure reflects*your view*of the company’s Cash Flow, Discount Rate, and Cash Flow Growth Rate based on your expectations.

The second and third issues – the Assets and investors we’re including – explain the origins of **Equity Value** and **Enterprise Value:**

**Equity Value:**The value of**ALL**the company’s Assets, but only to**EQUITY INVESTORS**(common shareholders).**Enterprise Value:**The value of only the company’s**core-business Assets**, but to**ALL INVESTORS**(Equity, Debt, Preferred, and possibly others).

You can calculate a single company’s Current Equity Value, Current Enterprise Value, Implied Equity Value, and Implied Enterprise Value.

They each mean something slightly different, and you’ll almost always calculate all of them when valuing or modeling a company.

To move *from* a company’s Equity Value *to* its Enterprise Value, use both parts of the two definitions above:

**Equity Value**= Value of Core-Business Assets + Value of Non-Core-Business Assets**Enterprise Value**= Value of Core-Business Assets

Therefore, you subtract non-core-business Assets (Cash, Investments, Associate Companies, and anything else unrelated to the company’s operations) as the first step in this move.

Then:

**Equity Value**= Value to Equity Investors**Enterprise Value**= Value to Equity Investors + Value to Debt Investors + Value to Preferred Investors (and possibly others)

Therefore, you add Liability & Equity line items that represent other investor groups as the second step in this move.

The most common items are Debt, Preferred Stock, and Noncontrolling Interests, but there are others, such as Unfunded Pensions, as well.

Here’s a simple example:

Here’s the “Equity Value” view of Coach’s Balance Sheet:

To move from Equity Value to Enterprise Value, you subtract the non-core-business Assets: Cash, Short-Term Investments, and Long-Term Investments.

And on the other side of the Balance Sheet, you add Debt and Preferred Stock since they represent other investor groups:

Neither Equity Value nor Enterprise Value is “correct”; they’re just different.

**The Implications of These Definitions: Why Enterprise Value Matters**

There are a few important implications of these definitions:

**Implication #1: In Theory, Financing Events Will Not Affect Enterprise Value, But They May Affect Equity Value**

These types of questions are common in interviews:

- A company issues $500 in Dividends. What happens to its Equity Value and Enterprise Value?
- A company raises $1,000 of Debt to repurchase Stock. What happens to its Equity Value and Enterprise Value?
- A company repurchases $700 of Stock using Cash. What happens to its Equity Value and Enterprise Value?

The *worst* way to answer these questions is to use the standard formula for Enterprise Value: Equity Value – Cash/Investments + Debt + Preferred Stock + Noncontrolling Interests.

That formula will make it **very** confusing because you have to think about whether or not each item changes.

Instead, use this 2-step process to decide on what changes:

**Step 1: What is responsible for this change? Something related to the company’s Common Equity (a stock issuance, repurchase, dividends, etc.), or something else?**

If the answer is “something related to the company’s Common Equity,” then Equity Value **will change**.

If the answer is “something else,” then Equity Value will **not** change.

**Step 2: Does a core-business Asset change?**

If so, Enterprise Value will change.

If not, Enterprise Value will not change.

**Example #1:** A company issues $200 of common shares to acquire $200 in PP&E.

**Step 1:** A common stock issuance is responsible for this increase in PP&E. Therefore, Equity Value increases by $200.

**Step 2:** PP&E is a core-business Asset. Therefore, Enterprise Value increases by $200.

**Example #2:** A company uses $100 of Cash to repay $100 in Debt.

**Step 1:** A common stock issuance was not responsible for this change. It involved Cash and Debt, not stock. Therefore, Equity Value stays the same.

**Step 2:** Cash is not a core-business Asset. Therefore, Enterprise Value stays the same.

**Example #3:** A company issues $200 of common shares. It acquires another company for $100 and leaves $100 in Cash on its Balance Sheet.

**Step 1:** A common stock issuance was responsible for this change. Therefore, Equity Value increases by $200.

**Step 2:** The other company is a core-business Asset, but Cash is not. Therefore, Enterprise Value increases by $100.

**Implication #2: In Theory, Only Changes to a Company’s Core Business Will Affect Enterprise Value**

For example, all of the following changes might affect a company’s Current and Implied Enterprise Value:

**Example 1:**The company wins a major contract with a new customer, boosting its expected future Revenue and, therefore, its future Cash Flow.**Example 2:**The company closes down an unprofitable division, boosting its margins and its expected future Cash Flow.**Example 3:**The company negotiates a better supplier contract, boosting its margins and its expected future Cash Flow.

These changes will affect Enterprise Value because:

- They change the company’s expected future cash flow from its
**core business**. - They do
**NOT**change the cash flow just for one group of investors.**All**the investors are affected.

Only changes to a company’s core business affect its Enterprise Value, but *both* financial and operational changes affect its Equity Value.

If you’re wondering about the PP&E example above, $200 of additional PP&E will boost the company’s Enterprise Value by $200 because:

- In the long term, that PP&E will generate additional cash flow for the company’s
**core business**. - This additional cash flow will be available to
**all**the investors in the company.

**Implication #3: Metrics That Represent ONLY Equity Investors Pair with Equity Value, and Metrics That Represent ALL Investors Pair with Enterprise Value**

For this rule, it’s helpful to think about “who gets paid” at each step along a company’s Income Statement.

Initially, a company’s Revenue, Gross Profit, and Operating Income are available to **all investors in the company**.

When those increase, everyone benefits.

For example, higher Revenue makes it easier for the company to pay interest on Debt, Preferred Dividends, and Common Dividends.

But as you move down the Income Statement, you start eliminating different investor groups as they “get paid.”

Also, you start to reflect income and expenses from non-core-business Assets:

If a metric is *before* Interest Expense and Preferred Dividends have been subtracted, then you pair it with **Enterprise Value**.

If a metric is *after* Interest Expense and Preferred Dividends have been subtracted, then you pair it with **Equity Value**.

Common metrics that pair with **Enterprise Value** include Revenue, Operating Income or EBIT, NOPAT, EBITDA, and Free Cash Flow to Firm (i.e., recurring cash flow available to all investors).

Common metrics that pair with **Equity Value** include Net Income or Net Income to Common, Free Cash Flow, and Free Cash Flow to Equity.

**Why Enterprise Value is a Pink Unicorn**

Everything above represents a theoretical view of Enterprise Value: That it’s truly “capital structure-neutral,” and that only changes to a company’s core business affect it.

This graph represents that same theoretical view:

**a company’s capital structure**because of taxes, bankruptcy risk, and agency costs.

*does*affect its valueFor example, at first, additional Debt helps a company Debt is cheaper than Equity and Preferred Stock (due to the tax-deductible interest, among other factors).

But Debt starts hurting the company past a certain point because the bankruptcy risk climbs to a much higher level, and there’s a higher chance of conflict between the different investor groups (“agency costs”).

So, this graph is a more accurate depiction of a company’s Enterprise Value as its capital structure changes:

*Implied*Enterprise Value than

*Current*Enterprise Value.

If a company raises more Debt, its Current Enterprise Value will probably *not* change overnight.

But if it is expected to have more Debt permanently, its Current Enterprise Value will start to change.

The bottom line is that Enterprise Value is **not** truly “capital structure-neutral,” as some sources claim.

It’s better to think about the concept like this: “Changes to a company’s capital structure tend to affect the company’s Equity Value by *more* than they affect its Enterprise Value.”

Finally, there’s ambiguity in the Enterprise Value calculations because not everyone agrees on what constitutes a “core-business Asset” or an “investor group.”

As a result, there are disagreements over how to treat certain, more advanced items that go into the calculation.

My advice is to focus on the basic items that everyone can agree on – Cash, Debt, Preferred Stock, and so on – as well as common transactions that affect those items.

**Challenge Round: Test Yourself**

So, how well do you understand these concepts?

To test yourself, answer these questions on Equity Value and Enterprise Value:

- Explain why you add Unfunded Pensions when moving from Equity Value to Enterprise Value. Also, explain the tax treatment.
- Explain
**INTUITIVELY**how Implied Enterprise Value might be negative. Your answer should be 1-2 sentences, and it should not include any formulas or numbers. - A CEO picks up $200 in Cash on the street and adds it to the company’s bank account. Explain what happens to Equity Value and Enterprise Value
*using the “2-step rule” for changes.***Hint:**Think about how you would record this transaction on all three financial statements. - A company generates $100 in Net Income. Does its Enterprise Value change? If so, what is the intuition behind it? If not, what would cause it to change?

**NOTE:** You won’t find the exact answers to these questions in the guide. But I may answer them in the comments, depending on the quality of your responses.

Good luck!

- Equity Value, Enterprise Value, and Valuation Multiples – Written Guide (PDF)
- Excel Examples for Equity Value and Enterprise Value

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### Comments

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Please review my answers for your last 4 Qs:-

1) Unfunded pensions will have to be funded by future cash flows that is part of core business activities. Hence, they are included in Enterprise Value

2) Answered in the comments because of negative cash flows in the future, wherein you would move to relative valuation.

3) Enterprise Value will remain unchanged but Equity Value will increase. In the balance sheet, reserves and cash will go up. In the income statement, non-operating income will increase. In cash flow statement, cash flow from financing will increase.

4) Depends on if increase in net income is through core business or non-core business.

1) No.

2) Yes.

3) Partially correct. Your walk-through on the statements is off.

4) No (you sort of have the idea, but you’re thinking about the wrong statement).

Brian,

How are you?

I’d like to know if a company w/ high growth rate or margin, in general, has the numerator (EV) or the denominator (EBITDA) more increased. I thought that is good to have great margins and growth for the company`s value but, in the other hand, it can affect the EBITDA, reducing its multiple. So, which one is greater, EV or EBITDA given the high growth and margin?

Thank you,

Joseph

It’s impossible to answer that question without knowing the specific numbers and the discount rate. Going from 5% to 6% growth won’t change much, but 5% to 50% would obviously be a dramatic difference and would likely boost all its multiples, meaning its Enterprise Value would almost certainly increase by more.

In that case (5% to 50%), possibly, would the impact be greater in the EV or EBITDA (numerator or denominator)?

“meaning its Enterprise Value would almost certainly increase by more.”

Brian,

Why, in general, P/E multiple is higher than EV/EBITDA multiple, even for capital intensive companies?

Thank you,

Marcos

Because generally, a company’s Net Income is lower than its EBITDA by a bigger percentage than its Equity Value is lower than its Enterprise Value. Just think about a company with a 20% tax rate, minimal cash, and no debt or preferred stock: Equity Value and Enterprise Value will be almost the same, but the 20% tax rate alone means that Net Income will be at least 20% lower than EBITDA. And if you factor in D&A as well, Net Income might be 25% or 30% lower (or more… obviously it varies based on industry, but you get the point).

Hi,

Great Post! Just had a question regarding the enterprise value for a private company. How would you take into effect the FMV of the assets? Since they are recorded at book value and would be effectively report a much lower Enterprise value.

You can’t calculate Current Enterprise Value based on market values for private companies. Only Implied Enterprise Value means something, and you have to calculate it with the usual valuation methods. Private companies do not have publicly listed/traded share prices, so that is the only option (unless the company has recently raised funding, but that only applies to startups in most cases).

Brian,

Amazing article! I really need to know:

When we use the FCFE, we get directly the Equity Value or we need to add non operating assets/ liabilities, as cash for instance, to get it? (Because FCFE is calculated just with cash flows… I could not see the cash and the other assets on the calculation, which is part of the Equity Value, after all, is the value of everything to all investor)

And why we don’t use the Cash Flow Statement instead of FCFE (the major differences)?

Thank you very much,

Steve

No, you get the Implied Equity Value directly. Equity Value reflects all assets, both core and non-core, so you don’t need to add anything to it. FCFE should include cash flows from non-core assets as well (which is why it should start with Net Income… not Operating Income). The CFS includes non-recurring items and is often ridiculously long, so not practical to use in valuations.

Brian!

Why the majority of people are still calculating Equity Value in this way: Equity = EV – Debt + Cash, not considering other non operating assets and liablities (just the cash)?

Thank you,

Lucca

Because in most cases, the simpler formula works because many companies have minimal non-operating assets/liabilities (except for cash and debt).

Hi Brian, thanks for the great article. It really helped me understand enterprise value.

I’m still a little confused with the concepts though. First of all, when moving from enterprise value to equity value, why do we only subtract interest-bearing debt but not all liabilities? For example, let’s say a company bought some machines and hasn’t paid in cash, making the company possess $100 worth of other payables. Although these payables are not interest-bearing debt, shouldn’t it be subtracted from the total firm value as it is something that’s not attributable to equity investors? Likewise, shouldn’t all liabilities be subtracted rather than only the interest-bearing debt?

Also, this is a minor question but if a company has sold some machines and hasn’t been paid yet(classified as other receivables), should that be added to enterprise value when moving to equity value? I’m not sure if it’s really a non-operating asset that should be considered in this case.

Because interest-bearing debt is related to the company’s finances, not its operations. Other liabilities such as accounts payable are operational in nature, so you do not subtract them. Regardless of how a company eventually decides to finance its purchase of these machines, accounts payable will be created as an intermediate step in the process. That is why it’s an operational item – it doesn’t depend on a specific type of financing.

You typically subtract the net assets of discontinued operations when moving from Equity Value to Enterprise Value because they are considered non-core at that point.

Hello Brian,

On your article, you mentioned that the equity value includes the value of core asset + non-core asset and EV only include the core assets, if that is the case, can I interpreted as any changes on the core asset on the balance sheet, would affect both EV and equity value?

If that’s the case, under “Implication #1” – Step 1: why would you say that if the change is related to the company’s common equity, it would change the company’s equity value, if it is “something else”, then the equity value will not change?

A company can use debt to purchase core-asset (say PP&E) which will affect the company’s core-asset value, and since Equity value = value of core-asset + non-core asset, then shouldn’t the company’s equity value change as well?

You can’t say that because if the change was related to the company’s Debt (for example), it will affect only the company’s Enterprise Value.

For Equity Value to change, an Asset must change and it must be *caused* by a change in the company’s shares (something the equity investors did).

Using Debt to purchase PP&E will not affect the company’s Equity Value because the change is attributable to a different investor group (the Debt investors).

Thanks Brian! Also, can I think about it this way, separate the process (in my example) into two isolated but subsequence process? first, change of debt cause cash to increase, which has no effect on the company’s equity (that’s why equity value doesn’t change on this step). Second, company use this cash to purchase core-asset, which change the company’s EV but not equity value.

Would my thought process be correct this time?

Yes

Hello Brian,

Thanks for the great article. I won’t how would the EV and Equity change, if the company raised 50% debt and 50% equity to purchase a $100 PP&E. I know that EV will go up by $100, because PP&E is a core asset, but would equity value go up by $100 as well? or up by $50?

Equity Value will increase by $50 because the company only issues $50 of Equity to do the deal.

Thanks Brian!

Thank you for this!

What if? EV of of the Company is significantly lower than its Equity Value ? I have been referred a case, in that case Football Club Enterprise Value (EV) was assessed 3.9.2M To 6.7M Pounds whereas Equity Value was 56.2M Pounds due to bulk of cash received by the Football club was retained as Cash on the Balance Sheet on valuation date.

If this is the case where Enterprise Value < Equity Value so what would be the right purchase price for the Buyer of business.

I can’t say without seeing the details of that deal, but the effective purchase price is usually closer to Enterprise Value, though it’s still different because of the exact treatment of cash/debt, transaction fees, and so on.

The article is quite good, thanks!. However, I still have a doubt. For a non public company, a private investor that would buy the whole company it would pay the enterprise value and if it bought part of the company it would be consider the equity value or in both cases it would be the equity value that the investor should consider?.

Thank you

It depends on how the private investor buys the entire company, so you need to look at the terms to say anything definitive. A purchase of the company will most likely be closer to its Purchase Enterprise Value, and the valuation in

a minority stake deal will likely be based on something closer to the company’s Purchase Equity Value.

how do you calculate purchase enterprise value in a merger model?

The normal way… except increase the target’s Equity Value by (1 + Purchase Premium) and then add/subtract the normal items.

Hi, Brian, thank you very much for this useful guide. But I have some misunderstanding:

You write, that implied Equity value could be negative, because it is just derived from EV and everything could happen here. But as far, as I see, Equity value could be negative, if Net Debt (assuming there is not any other non-operating assets or claims) is more than Enterpsie value. And I think, that it is impossible, because in this case Net Debt will be valued at discount, since only part of Net Debt will be guaranteed by the value of business. So in this case market value of debt will be equal to Enterpsie value and implied Equity value will be zero.

Another case, that equity value could be negative, if we derive it through FCFE model and we have negative terminal value. But is it applicable to use DCF here? May be we should use liquidation value method and in this case equity value may occur to be positive?

Could you please write me, what are the flaws of my suggestions, and if everything is right, what is the particular case, when Equity value could be negative? Thank you very much.

I think you’re over-thinking this concept. Implied Equity Value (or Implied Enterprise Value) could be negative if the company generates negative cash flow and it never turns positive in the future (e.g., doomsday scenario for Uber). In that case, the company is worth $0 today and it will require additional contributions from you, the investor, to continue running. That’s why a company could be worth a negative amount – not only is it worth nothing, but it will actually cost you something to own in the future.

Thank you for your response, I see your point. And could you please elaborate on using the liquidation value method in case of negative cash flows? Is DCF still applicable to use in case of negative cash flows going to infinity?

Yes you can still use a DCF, but in that scenario, a Liquidation Valuation would be more appropriate, as a company isn’t worth much if it has negative cash flows forever.

I must say that you brilliantly explained this way better than my university institution have ever managed to do (especially the MM theorem part). I guess sometimes a less academic approach to explain complex problems is good for understanding the whole picture!

Cheers.

Thanks for reading!

So, in a DCF calculation, using levered cash flow returns equity value and unlevered cash flow returns enterprise value? Assuming that’s correct, then if you subtracted debt from the enterprise value you’d get to equity value and in the equity value scenario you don’t need to subtract debt because that has already been factored in?

Yes.

In terms of the fourth question at the end, would the answer be the unchanged for enterprise value? Since the caah increased from net income will be cancelled out by concluding the cash.

Yes, but there’s a more intuitive explanation for why Enterprise Value remains unchanged.

Brian,

I´ve seen and heard of bankers here in Brazil moving from EV to Equity Value by also adding Net Working Capital (e.g. Inventory + Receivables – Payables), for the RETAIL sector.

The theory is they se how much the current NWC exceeds its historical avarage and add that difference, but in practice they just add LTM Inv. and Receivables and subtract Payables.

This happened both at a buldge bracket I did an internship at and at a friend´s boutique.

Am I wrong to assume this can´t be done, since you already factor in NWC in your future free cash flows when calculating Enterprise Value? Is this just creative accouting for boosting Valuation, which ironically can backfire if the NWC is negative? Or am I missing something here?

That seems very questionable to me. Working Capital is always related to the company’s operations, so it should not differ between Equity Value and Enterprise Value (and it’s already factored into Free Cash Flow used to calculate the implied version of either one). It seems like a way to artificially boost a company’s value with thin justification.

Hi Brian,

I’ve encountered a company with interesting balance sheet items and this gives the calculation of EV some difficulties. The company is called Aimia Inc. (TSX:AIM). It’s the owner and operator of several frequent flyer loyalty programs (including Aeroplan in Canada). It has large amount of redemption liabilities on its balance sheet. My question is, should you include the redemption liability in its EV?

What’s more confusing is that the company is required to hold cash reserves on the balance sheet against the redemption liabilities (but it only covers the small fraction of the redemption liability, the thinking is that the ongoing cash flow generated will cover most of the redemption liabilities). My question is, should I include this cash reserve in my net debt calculation?

Thank you for your insights.

Best,

Jason

If this redemption liability is operational i.e. it is something that the company plans to pay out to customers in the future, it does not represent another investor group and should not be added when calculating Enterprise Value. You typically count all Cash as a non-core Asset and subtract it, even though that is not quite accurate since all companies need a minimum Cash balance to keep operating (and since some companies may keep reserves for various purposes).

Brian,

How would you overcome an issue of changing capital structure when trying to find WACC? Assume we are not provided with a target capital structure of the company.

Is it correct to use industry average capital structure to find wacc? I don’t think it is appropriate to use current capital structure of the company, as it is changing and wacc is used to discount future cashflows with different capital structures.

Change the Discount Rate each year and make it move closer to the one represented by the company’s long-term capital structure goal (e.g., 8% current Discount Rate to 10% target over 10 years – make it go up by 0.2% each year). If you don’t have the company’s target, take the median capital structure percentages from the comparables.

Good article.

Enterprise value: Market Cap + Net Debt (short term + long term + pref stock – cash)

Equity value: Enterprise value – debt

Correct?

No. See Key Rule #7 in the guide. To move *from* Enterprise Value to Equity Value, you have to do the reverse and add non-core Assets and subtract items that represent other investor groups. So your equation is missing several terms.

“Company Value = Cash Flow / (Discount Rate – Cash Flow Growth Rate)

Company Value = $100 / (2% – 3%) = –$10,000

Assuming that this is the cash flow to ALL investors and that the Discount Rate is WACC, then

the company’s Implied Enterprise Value is negative $10,000.”

This is incorrect. You cannot have a (perpetual) growth rate larger than your required rate of return. As your growth rate approaches your req. rate, the implied value of your firm is infinite, but then flips negative as you grow faster than the rate required to invest? Of course not. This model works only for all r>g.

Thanks for pointing that out. Yes, that was fixed in an earlier version. Somehow an older version was posted, so we just replaced it and changed that example.

Worth to mention that when finding terminal value, growth rate used should be average predicted GDP growth rate of that country (in accordance to the mean reversion theory). In reality, most analysts use a combination of predicted inflation rates and predicted gdp growth rates to find g in the formula.