Equity value to enterprise value
What the shareholders own versus what the whole business is worth, and the bridge between them.
- Build enterprise value from equity value, line by line
- Explain why debt, preferred stock and minority interest are added, and cash is subtracted
- Run the bridge backwards from an enterprise value to a share price
- Pair enterprise value and equity value with the right metrics
The intuition
You buy a house. The seller owns it outright except for a $150,000 mortgage, and you agree to pay them $200,000 for their share. You also take over the mortgage. On moving day you find $20,000 of cash in a safe that comes with the house.
What did the house really cost you? The $200,000 to the seller, plus the $150,000 mortgage you now owe, minus the $20,000 you found: $330,000. The $200,000 is the equity value: what the owner's slice was worth. The $330,000 is the enterprise value: what the house itself cost, whoever it is owed to.
Equity value is what the shareholders own. Enterprise value is what the operations are worth to everyone with a claim on them. To get from one to the other, add every other claim and subtract the cash.
Why it works
- Equity value is share price × shares outstanding: the market value of the common shareholders' slice. In practice use the diluted share count (chapter 3).
- Add debt. A buyer of the whole business inherits the obligation to repay it, so it is part of the true cost.
- Add preferred stock. Preferred holders rank ahead of common shareholders and must be paid out too.
- Add minority interest. If the company owns 80% of a subsidiary, its financials include 100% of that subsidiary's EBITDA. Adding the 20% owned by others keeps enterprise value on the same basis as that EBITDA.
- Subtract cash. The buyer gets the cash and can use it to pay down the debt it inherited, so the operations cost that much less. These questions subtract all of it; strictly, a business needs some cash to run.
Because enterprise value belongs to every capital provider, it pairs with metrics measured before anyone is paid: revenue, EBITDA, EBIT and unlevered free cash flow. Equity value belongs to shareholders only, so it pairs with metrics after lenders are paid: net income, earnings per share and levered free cash flow.
| Equity value | 800 |
| + Debt | 1,100 |
| + Preferred stock | 1,150 |
| + Minority interest | 1,180 |
| − Cash | 1,080 |
| = Enterprise value | 1,080 |
Net debt is 300 − 100 = 200. Enterprise value is above equity value because the company owes more than it holds in cash.
The formulas
What the shareholders' slice is worth in the market.
What the company owes, after using its cash to pay some of it off.
Every claim on the operations, less the cash a buyer inherits.
The same bridge run backwards: strip out the other claims, add the cash back, share out what is left.
Worked example
The bridge in its full form. Start from what the shareholders own and add one line at a time.
See it move
Same company. Change the share price and each claim in the bridge, then pay a special dividend out of cash.
- Raise the cash. Enterprise value falls by exactly the same amount, and equity value does not move.
- Add preferred stock or minority interest. Each dollar lifts enterprise value by a dollar, with equity value unchanged.
- Push the cash above debt, preferred and minority interest combined. Enterprise value drops below equity value: part of what shareholders own is simply cash.
- Move the dividend. Equity value and cash fall together, and the two enterprise value bars stay level.
Run it backwards
Same company, reversed: a DCF has valued the operations. What share price does that imply?
A DCF of unlevered cash flows gives enterprise value, the value of the operations to everyone. Shareholders only get what is left after the other claims, plus the cash. So take off debt, preferred and minority interest, add back the cash, and divide by the shares.
This is the last step of every DCF, and the reason you cannot skip the bridge: a share price comes from equity value, never straight from enterprise value.
Traps
Say it in the interview
“Walk me from equity value to enterprise value. Why do you add debt and subtract cash?”
Check yourself
4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.
Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.
- EV = equity value + debt + preferred + minority interest − cash.
- Cash is subtracted because a buyer inherits it.
- EV pairs with EBITDA and unlevered metrics; equity value with net income and EPS.
- Share price = (EV − other claims + cash) ÷ shares.