In this article, we will see how to calculate equity value and enterprise value.
A few weeks back, a friend of mine bought a house. He was happy to share the news with all friends. He threw a big party and celebrated the purchase of this true asset. While discussing the cost of this asset, he explained the various costs attached to it. Actual acquisition cost of the house was 10% more than the list price. Why 10%? It included hidden costs like repairs to be done, unpaid bills, different obligations and various registration costs. But, my friend benefited from furniture which he got free with the house.
Okay! You will ask me what this house story has got to do with the headline of this article, right?
Now, imagine you are an equity research analyst and working on the valuation of a company to be acquired. Take the essence of the house story in this context and you will understand the difference between equity value and enterprise value clearly.
Equity Value vs Enterprise Value
Equity value will tell you what a company is worth and enterprise value tells you how much it would cost to acquire a company. So, in my house story, the list price is equity value, whereas, the addition of 10% to list price would give you enterprise value of that house.
Enterprise value will take into account the debt part, obligations and the free things like cash that the company has.
Calculation of equity value and enterprise value
How do you calculate equity
Valuation of Equity/ Equity Value = Common Shares Outstanding * Share Price
How to calculate enterprise value
Enterprise Value = Equity Value – Cash + Debt + Minority Interest + Preferred Stock
Why subtract Cash?
Remember the free furniture my friend got with his house purchase? That’s a gift and his cost of acquisition would be reduced by the furniture cost. How? Simple, he doesn’t have to invest money in buying new furniture and that will save him a lot of money. The same way, if you are acquiring a company having some cash (including short term and liquid marketable investments) on its balance sheet, you will pocket that cash and your acquisition cost will be reduced effectively by that amount.
Why add Debt?
If the company has debt (loans) on its balance sheet, you will have to pay that loan. You will have to pay the debts that include short/long term debts, revolvers, mezzanine and so on.
Why do you add minority interest to enterprise value/Why add Minority Interest?
When you own more than 50% of another company, the minority interest comes into the picture. It is the percentage that you don’t own.
Why add Preferred Stock?
Preferred stock is similar to debt which has fixed dividend. You will find Preferred Stock listed on the Liabilities side of the Balance Sheet.
My friend is happy with the newly acquired house. As an analyst, your role is to see your clients happy with the acquisition of the companies.
I hope, you are now clear with these two concepts: Equity Value and Enterprise Value.
Have you bought any asset that explains these two concepts- Equity Value and Enterprise Value clearly? Share your experience here.
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