Equity Value & Enterprise Value - Advanced

Question 1

Are there any problems with the Enterprise Value formula you just gave me?

Answer 1

Yes – it’s too simple. There are lots of other things you need to add into the formula with real companies:

• Net Operating Losses – Should be valued and arguably added in, similar to cash. • Long-Term Investments – These should be counted, similar to cash.
• Equity Investments – Any investments in other companies should also be added in, similar to cash (though they might be discounted).
• Capital Leases – Like debt, these have interest payments – so they should be added in like debt.
• (Some) Operating Leases – Sometimes you need to convert operating leases to capital leases and add them as well.
• Unfunded Pension Obligations – Sometimes these are counted as debt as well.

So a more “correct” formula would be:

Enterprise Value = Equity Value – Cash + Debt + Preferred Stock + Noncontrolling Interest – NOLs – LT and Equity Investments + Capital Leases + Unfunded Pension Obligations

In interviews, usually you can get away with saying “Enterprise Value = Equity Value – Cash + Debt + Preferred Stock + Noncontrolling Interest” I mention this here because in more advanced interviews you might get questions on this topic.

Question 2

Should you use the book value or market value of each item when calculating Enterprise Value?

Answer 2

• Technically, you should use market value for everything.
• In practice, however, you usually use market value only for the Equity Value portion, because it’s almost impossible to establish market values for the rest of the items in the formula – so you just take the numbers from the company’s Balance Sheet.

Question 3

What percentage dilution in Equity Value is “too high?”

Answer 3

• There’s no strict “rule” here but most bankers would say that anything over 10% is odd. If your basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check your calculations – it’s not necessarily wrong, but over 10% dilution is unusual for most companies.