BIWS 04-04: Eq Val, EV, and Valuation Metrics and Multiples

What do Equity Value and Enterprise Value MEAN?

When you look at the value of a company’s net assets, everything it owns, but only to the common shareholders, that is your equity value.

When you look at the value of a company’s Net Operating Assets, or its core business, to all investors, that is your Enterprise Value.

Why do you use both Equity Value and Enterprise Value? Isn’t Equity Value more accurate?

First of all, equity value isn’t more accurate, it’s just a different concept, and whether you use Eq Value or EV is important to different investors. In valuation, whether your output gives you that Eq.Value or EV depends on what method you use.

The advantage of EV and TEV-based multiples is that they are more capital structure neutral, so they don’t change as much as equity value and the corresponding multiples.

The reason you use both is because no investor group acts in isolation. Raising debt, for example, makes the risk and return dynamic different for equity investors, too.

Why do you pair Net Assets with Common Shareholders in Equity Value, but Net Operating Assets with All Investors in Enterprise Value? Isn’t that an arbitrary pairing

It is not arbitrary.

The reason Net Assets is paired with common shareholders is because CSE can be generated both internally (net income) and externally (stock issuance), so the company can use it for its core internal business (the operating assets) and the more external business interests (the non-operating assets).

The reason that Net Operating Assets is paired with all investors is because a company will usually only look to raise funds from investors to pay for things having to do with its core business, the operating assets.

What’s the difference between Current Enterprise Value and Implied Enterprise Value?

Current enterprise value is based on what the market things the companies core business is worth to all of its investors. To calculate it, you start with the Current Equity Value, subtract Non-Operating Assets, and add L&E line items that represent investor groups that aren’t common shareholders.

Then, Implied Enterprise Value is the output of a forward-looking valuation from something like a DCF, comps, or precedent transactions.

Why might a company's Current Enterprise Value be different from its Implied Enterprise Value?

Well the formula for company value is Cash Flow/(Discount Rate - growth rate). The market sets the Current EV, which means it is makes implicit assumptions for future cash flow growth and the discount rate. If you disagree on one of those elements, most likely an element that feeds into one of them, then you Implied EV may differ from the Current EV.

Why do you subtract Cash, add Debt, and add Preferred Stock when moving from Equity Value to Enterprise Value in the “bridge”?

Equity value represents Net Assets, so you have to go from that to just the Net Operating Assets. In order to make that transition, you have to get rid of the non-operating assets like cash. This would also include subtracting out Equity investments, assets held for sale, and assets associated with discontinued operations.

You are also going from only common shareholders being considered under Equity Value, to all investor groups under Enterprise Value. So, you have to add in the interests of those other investor groups like debt and preferred stock. This could also include underfunded pensions, capital/finance leases, and noncontrolling interests.

You're about to buy a house using a $600K mortgage and a $200K down payment. What are the real-world analogies for Equity Value and Enterprise Value in this case?

Equity value is the part you own, the $200K. Enterprise value is the entire value of the property to everyone interested (you and the bank) and is $800K

Could a company’s equity value ever be negative?

Their current equity value can never be negative because neither the shares outstanding, nor the share price, can be negative. But, the implied equity value can be negative since it is based on assumptions you get to make. If you make a DCF, for example, and the implied enterprise value is $0, and the company has debt, then after you make the bridge your equity value will be negative. You would still say that equity value is $0, though.

Could a company’s enterprise value be negative?

Yes, both the current and implied could be because of the bridge. If a company holds a lot of cash (or other non-operating assets), an amount of cash that exceeds the combination of its other investor interests (debt, NCI, underfunded pensions) and equity combined, then the EV will be negative.

Why do financing events such as paying dividends or issuing debt not affect Current Enterprise Value?

Because financing events don’t impact Net Operating Assets. Dividends affect cash and CSE, debt issuance affects cash and debt. None of these line items are part of the core business, they aren’t operating assets or liabilities. So, since net operating assets don’t change, then Current EV can’t either.

You estimate a company’s Implied Value with Company Value = Cash Flow / (Discount Rate – Cash Flow Growth Rate), where Cash Flow Growth Rate < Discount Rate.

Will this give you the company’s Implied Equity Value or Implied Enterprise Value?

It depends on the type of cash flow and discount rate that you use. If you are using unlevered cash flow, or cash flow available to all investors, and WACC, then you will get Implied Enterprise Value. If you are using levered cash flow, or cash flow only available to equity investors, and just the cost of equity, then you get implied equity value.

If financing events do not affect Current Enterprise Value, what DOES affect it?

Current Enterprise Value is affected by changes to line items that have to do with the company’s core business, they affect Net Operating Assets. This is things like using cash to purchase PP&E or raising debt to purchase inventory.

Is it possible for a single change to affect both Current Equity Value and Current Enertprise Value?

It is if Net Operating Assets and CSE simultaneously change. This could happen if a company issued stock to purchase PP&E, for example.

Why does Enterprise Value NOT necessarily represent the "true cost" to acquire a company?

There are a couple reasons. First of all, when you acquire a company, you are typically going to be paying a premium, sometimes referred to as a “control premium”. In this M&A process, the company is also going to incur costs related to M&A advisory, accounting, legal services, etc. None of these are reflected in EV.

The main reason, though, is that how you treat the seller’s existing debt and cash is different depending on the deal. The buyer might not pay down all the debt and instead chose to finance it or replace it. With the cash, the buyer might not get all of that either.

In theory, if Companies A and B are the same in all respects, but Company A is financed with 100% Equity, and Company B is financed with 50% Equity and 50% Debt, then their Enterprise Values will be the same.

Why is this NOT true in reality?

This isn’t true in reality because the equity value is impacted by the existence of debt. Depending on how much debt there is and the cost of it, WACC may increase or decrease. Because debt is cheaper than equity, WACC will first go down as debt is added, but past a certain point, the interest payment and future maturities of that debt raises the cost to the point where WACC starts increasing again.

EV is less affected than Eq. Value, but it is still impacted.

What about private companies? How do the concepts of Equity Value and Enterprise Value work there?

They still exist, but because there is no market for them, you cannot just calculate equity value with shares outstanding and share price. Instead, you have to look at private market activity and transactions.

You focus more on implied than current.

A company issues $200 in Common Shares. How do Equity Value and EV change?

CSE is up by $200, so Eq value is up by $200.

NOA is unaffected since cash and CSE are nonoperational, meaning TEV doesn’t change. Also, looking at the bridge the extra cash offsets the higher equity value.

A company issues $200 in Common Shares, and it uses $100 from the proceeds to pay Dividends to the common shareholders. How does everything change?

CSE is up by $200 at first from the common stock issuance, but then it goes down by $100 from the dividend payment. So, net, it is up by $100. This means Eq Value is also up by $100.

NOA don’t change from financing activities, and neither dividends nor common shares are operational, so TEV doesn’t change.

The company decides to use the $200 in proceeds from new Common Stock to acquire another business for $100 instead. How does everything change?

CSE - is up by $200 from the issuance of common stock, so equity value is up by $200.

NOA - up by $100 from the purchase of another business, an operating asset. So, TEV is up by $100

What if the company uses $100 from new common stock to acquire an asset rather than an entire company?

It depends. If the asset is part of the core business, an operating asset like a factory, then it would increase the TEV. But, if the asset is non-operating, say a short-term investment, then only equity value would have been impacted by the equity raise.

What happens if this company issues $200 in Debt to fund a $100 Asset acquisition instead?

CSE isn’t impacted by debt issuance, so equity value stays the same.

NOA isn’t affected by the financing, but if the asset purchased will be a part of the core business, an operating asset, then TEV will increase by $100.

A company issues $200 of Debt to fund a $200 Equity Purchase Price acquisition of a company with $150 in Common Shareholders’ Equity.

How do Equity Value and Enterprise Value change, considering that the acquirer must create Goodwill?

Equity value stays the same since issuing debt does nothing to CSE.

TEV increases by $50 from the goodwill, which is an operating asset, and by $150 by the acquired company’s assets. So, TEV is up by $200 total.

A company issues $100 in Preferred Stock to purchase $50 of PP&E. How do Equity Value and Enterprise Value change?

Preferred stock is not a part of CSE, so Equity Value stays the same.

Since the $50 of PP&E is operating, then TEV will increase by $50.

Now the company issues $100 in Preferred Stock to repurchase $50 of Common Stock. How do Equity Value and Enterprise Value change?

CSE is down by $50 from the purchase of treasury stock, so equity value is down by $50.

TEV is unaffected because no operating assets or liabilities change.

A company issues $150 of Debt and $50 of Common Stock to acquire $175 of PP&E and $25 of Short-Term Investments. How do Equity Value and Enterprise Value change?

CSE increases by $50 from the common stock issuance, none of the other events impact it, though. So, equity value is up by $50.

NOA is up by $175 from the purchase of PP&E, which is an operating asset, but is unaffected by the rest of the actions, which are non operating. So, TEV is up by $175.

Current Equity Value represents the Market Value of ALL Assets.

But if that’s the case, why doesn’t a $100 Debt issuance boost Equity Value? The company receives $100 in extra Cash from this issuance, which should boost its Total Assets.

Well Equity value represents the value of Net Assets, not total assets. And, the equity value is only what the Net Asset’s market value is to equity investors.

With that understanding, we know CSE remains the same in this situation, so the market value to equity investors doesn’t change.

Also, Net Assets doesn’t change because the debt and the cash would offset,

A company purchases $100 of Inventory using Cash. How do Equity Value and Enterprise Value change?

CSE isn’t impacted, so equity value stays the same.

NOA increases by $100 since inventory is an operating asset. So, TEV is up by $100.

A company purchases $100 of Inventory using Cash. Now assume the Inventory is sold for $200 and walk me through how the entire process from beginning to end affects Equity Value and Enterprise Value.

On the Income Statement, Revenue is up by $200, and Pre-Tax Income is up by $100 (due to the $100 of Inventory now being recognized as COGS). Net Income increases by $75 at a 25% tax rate.

On the CFS, Net Income is up by $75, and there are no other changes (Inventory went up and now goes down), so Cash is up by $75 at the bottom.

On the Balance Sheet, Cash is up by $75 on the Assets side, and CSE is up by $75 on the L&E side.

Since CSE is up by $75, Eq Val increases by $75.

NOA does not change because Cash is not an Operating Asset and no Operating Liabilities change, so TEV stays the same.

A company collects $200 of cash from a customer upfront for a service that it has not yet delivered. How do Equity Value and Enterprise Value change?

This creates an operating liability, unearned revenue, of $200.

CSE doesn’t change because CSE doesn’t change. The $200 can’t be recognized as revenue and flow through into NI until the service is delivered.

NOA is down by $200 because of the increase in operating liabilities from the unearned revenue.

A company collected $200 of cash from a customer upfront for a service that it has not yet delivered. Now, the company delivers the service to the customer and recognizes the $200 as Revenue, along with $100 in Operating Expenses. Walk me through how the entire process from beginning to end affects Equity Value and Enterprise Value.

IS - Revenue is up by $200, OpEx is up by $100, pre-tax income is up by $100. Assuming a 25% tax rate, NI is up by $75.

CFS - NI starts up by $75, deferred revenue was up by $200 then down by $200, so there’s net no change. Cash is up by $75.

BS - Assets are up by $75 from the cash. Equity is up by $75 from CSE increasing by $75 from NI.

Equity value is up by $75 since CSE increased by $75. TEV does not change because there’s no change in operating assets or liabilities.

A CEO finds $100 of Cash on the street and adds it to the company’s bank account. How do Equity Value and Enterprise Value change?

Since this would be classified as an Extraordinary Gain on the IS, it is taxed at $25%, and increases NI by $75.

Since CSE is up by $75, equity value is up by $75.

Cash is non-operational, so NOA doesn’t change, meaning TEV stays the same.

A company experiences a disaster at one of its factories and records a $100 PP&E Write-Down. It also decides to issue $50 in Common Stock to get the funds required to replace this factory in the future. How do Equity Value and Enterprise Value change?

IS - The PP&E write down decreases Pre-tax income by $100, which at a 25% tax rate decreases NI by $75.

CFS - NI starts down by $75. You add back $100 from the write-down since that is non-cash, but then subtract $25 for the DTA that was created since write-downs don’t count towards cash taxes. You also have to reflect the $50 cash inflow in CFF from the stock issuance. So, net, your cash is up by $50.

BS - On the assets side, your cash is up by $50, your DTA is up by $25, but your PP&E is down by $100, so your assets side is down by $25. On the L&E side, NI decrease CSE by $75, by the stock issuance increases it by $50, so net equity is down by $25. So, both sides balance down by $25.

Since CSE was up down by $25 from the changes, equity value is also down by $25.

Since PP&E, an operating asset, is down by $100, your TEV is down by $100. Both Deferred Taxes and cash are non-operational.

A company has excess Cash. How do Equity Value and Enterprise Value change if the company uses the Cash to repay Debt vs. repurchase Common Stock?

Since both have to do with financing actions, NOA will not change. Cash, debt, and common stock are all non-operational.

CSE, then, will only change if the company repurchases common stock. This would reduce CSE, in-turn decreasing equity value. Debt doesn’t impact CSE, so repaying debt would not impact equity value either.

A company issues a press release indicating that it expects its revenue to grow at 20% rather than its previous estimate of 10%. How does everything change?

In the case where the financial projections for a company change, the intrinsic value is also going to change. In this case, since growth is better, both implied TEV and implied equity value will increase since they’re based on the company’s future cash flows.

Current equity value and TEV could also change if the stock price increases, but as far as the balance sheet goes nothing would change yet.

What IS a valuation multiple?

A valuation multiple is shorthand for a company’s valuation as a product of its cash flow, cash flow growth rate, and discount rate. Instead of showing all the steps, a multiple condenses it down to one number that is easy to compare across companies.

How do you use valuation multiples in real life?

You use them largely to compare the valuation of similar companies on a relative basis, also called a comparable companies analysis.

To make sure companies are similar, you need to look at things like size, industry, and location. The closest companies have similar discount rates and cash flows, so the growth rate should provide most of the differentiation. Then you compare by looking at different multiples, metrics, and growth rates of them.

Why are valuation multiples and growth rates often NOT as correlated as you might expect?

First of all, valuation multiples are based on expectations of future growth rates into perpetuity, which can differ from the current growth rate due to one-off events and future changes.

Also, valuation is based on cash flow, which can have a different growth rate than the growth rate of the metrics like EBIT and EBITDA that are ingrained in multiples.

Plus, the discount rate can play a larger role in multiples even across similar companies.

You’re valuing a mid-sized manufacturing company. This company’s TEV / EBITDA multiple is 15x, and the median TEV / EBITDA for the comparable companies is 10x.

What’s the most likely explanation?

The most likely explanation is that the expectations for the future growth rate of the company’s cash flows is higher than its peers.

Since we’re comparing to similar companies, the discount rates and cash flows should be roughly the same, so their impact shouldn’t be too much.

Would you rather buy a company trading at a 10x TEV / EBITDA multiple, or one trading at a 5x multiple?

It depends. If the companies have the exact same cash flow, discount rate, and cash flow growth expectations, then I’d rather by the one valued at 5x. But, there are a lot of unknowns here. The company trading at 10x could have a way higher growth rate, and I expect it to go even higher, while the company trading at 5x could be in terminal decline. They could also be completely different sizes, or in completely different industries.

When you’re looking at a multiple, it should always be considered relative to comparable companies. In isolation, it is hard to determine whether it signals under or over value.

Walk me through how you calculate EBIT and EBITDA for a public company.

EBIT is the same as operating income. So, you take gross profit and subtract operating expenses. Then, you add back any non-recurring charges like one-off impairments or legal fees.

Then, to get to EBITDA, you start from EBIT and add back D&A from the CFS, because D&A on the IS could be ingrained in other line items like SG&A or COGS.

Is anything different under U.S. GAAP vs. IFRS for these calculations? Do the multiples differ at all?

Under U.S. GAAP, EBITDA and EBIT fully subtract the operating lease rental expense, so when you do EV/EBITDA, for example, you don’t have to add the operating lease asset to the bridge.

Under IFRS, the operating ease expense gets split between depreciation and interest elements. The means that EBIT deducts the depreciation part, but EBITDA deducts neither. So, for multiples, you can’t use EBIT unless adjusted, and the have to add operating leases to enterprise value in EV/EBITDA.

How do you calculate “Free Cash Flow” (just FCF, not Levered or Unlevered FCF), and what does it mean? Are there any differences under U.S. GAAP vs. IFRS?

Free Cash Flow is calculated as CFO - CapEx. This assumes the CFO has already deducted net interest expense, taxes, and the entire lease expense. It is intended to show the discretionary cash flow a company generates, meaning what is left after keeping the core business running for things like paying down debt, making acquisitions, or returning capital to shareholders.

The only difference would be the way the CFS is set up, so if dealing with an IFRS company, you may need to reorganize the statement in order to get proper CFO with the net interest expense and full lease expense taken out.

The one other change is to make sure that you don’t add back all the D&A, because some of it is related to the lease expense that you need to subtract. So, only add-back the D&A unrelated to leases.

How do you calculate Unlevered FCF and Levered FCF, and how do you use them differently than normal Free Cash Flow?

Unlevered cash flow is NOPAT + D&A ± Change in Working Capital - CapEx

Levered FCF is Net Income to Common + D&A and sometimes other non-cash adjustments ± Change in Working Capital - CapEx - (Mandatory?) Debt Repayments + Debt Issuances (?)

UFCF is the variation cypically found in DCFs because it ignores capital structure by deducting interest expense. But, FCF is more useful when you just want to look at one company and see how much cash they could put towards paying down debt.

LFCF is used in a Levered DCF, but there is quite a bit of nuance about how to even calculate it.

If a company’s cash flow matters most, why do you use metrics like EBIT and EBITDA in valuation multiples rather than FCF or UFCF?

Unlike FCF and UFCF, EBIT and EBITDA have clear, simple calculations. They are already normalized for the same line items, whereas FCF and UFCF can have some differences in the line items included based on geography, industry, and IFRS vs GAAP. So, it is even more work to normalize them.

How do you decide whether to use Equity Value or Enterprise Value when you create valuation multiples?

You have to pair the numerator and denominator in a way that gets you an apples-to-apples comparison. For example, EBITDA is available to all investors, interest for debtholders, taxes for the government, and any preferred dividends haven’t been taken out, so, you pair it with EV, the value of the company to all those investors.

On the other side of the coin, you pair Net Income with equity value because Net Income to common is only available to your equity holders.

If a company has both Debt and Preferred Stock, why is it NOT valid to use Net Income rather than Net Income to Common when calculating its P / E multiple?

Because the equity value only represents the value of the company in the interest of common equity investors. Net Income hasn’t deducted preferred dividends yet, so it still factors in the interest of preferred stockholders.

You don’t want to use metrics that combine company values and investor types interested in that value, so you use Net Income to Common when dealing with equity value.

Should you use equity value or enterprise value with Free Cash Flow?

It depends.

If your FCF metric subtracts out net interest expense, so FCF or LFCF, you need to use equity value.

But, if Net Interest Expense is not deducted, which is the case with UFCF, you use EV.

What are the advantages and disadvantages of TEV / EBITDA vs. TEV / EBIT vs. P / E?

One multiple never tells the whole story.

TEV/EBITDA is good for getting a capital structure and capital intensity neutral gauge of a company’s core business performance, but it may cause companies to look “undervalued” if they have a high interest expense or D&A from high capex needs.

TEV/EBIT factors in capital intensity to some degree through D&A, and still ignores capital structure, but it has the same problem as TEV/EBITDA.

P/E is really not too useful because NI is so variable based on one-off charges, tax rules, capital structures, extraneous, non-core business activities. It is simple, though, and most people are familiar with it.

In the TEV / EBITDAR multiple, how do you adjust Enterprise Value?

In general, for purposes of uniformity, if a multiple excludes or adds back an IS expense, the numerator needs to add back the corresponding BS item.

In this case, because the denominator adds back the rental expense of your operating leases, you have to add back operating leases in the bridge to EV.

If you are dealing with a company that uses IFRS, then EBITDA already equals EBITDAR, and EV already adds back operating leases.

If EBITDA decreases, how do Unlevered FCF and Levered FCF change?

EBITDA is your revenue - COGS - OpEx excluding D&A

So, for it to decrease, either revenue dropped or one of the expenses increased. Either way, the operating income that is a core component feeding into both UFCF through NOPAT and LFCF through NI are going to decrease.

Now, if D&A or CapEx, or Change in Working Capital manage to offset one of those changes, then the metric could remain the same, but its unlikely.

What are some different ways you can calculate Unlevered FCF?

There are three main methods to calculating UFCF:

1. EBIT * (1-TaxRate) + D&A and Possibly Other Non-Cash adjustments ± Change in Working Capital - CapEx

2. (EBITDA - D&A) * (1-TaxRate) + D&A and Possibly Other Non-Cash adjustments ± Change in Working Capital - CapEx

3. CFO - (Net Interest Expense and Other Items Between Operating Income and Pre-Tax Income) * (1-TaxRate) - CapEx

When you calculate Unlevered FCF starting with EBIT * (1 – Tax Rate), or NOPAT, you’re not counting the tax shield from the interest expense. Why? Isn’t that incorrect?

Correct, and that is the point. You want UFCF to be capital structure neutral so that you can really just be analyzing the core business performance. If you don’t include the downside of debt, the interest expense, you can’t keep the benefit.

When you create “forward multiples” based on projections for metrics such as Revenue and EBITDA, how do you adjust Enterprise Value? Do you project it forward as well?

No, you never project or adjust TEV in this situation. Future expectations for TEV, and also equity value, are already baked into the numerator of these multiples.

Two companies have the same P / E multiples but different TEV / EBITDA multiples. How can you tell which one has higher Net Debt, assuming that each one has only Equity, Cash, and Debt in its capital structure?

It depends. If we assume the companies are the same size and have the same exact NI and EBITDA, then the company with a higher TEV/EBITDA would have higher Net Debt because the numerator is going to be larger.

That said, two companies can have the same P/E multiple and be very different sizes, which will impact the size of net debt. Meaning, we cannot tell which company has higher net debt, because two companies can both have P/E multiples of 10x, but one has NI of $100 and one has NI of $10. So, equity value is $1000 and $100 respectively. Then, if you say they have EBITDA of $200 and $20, with 10x EV/EBITDA for the first company and 5x EV/EBITDA for the second company, the first company has an EV of $2000 and net debt of $1000. The second company has an EV of $100 and no debt. So, clearly you cannot tell which one has higher net debt from multiples alone.

Two companies have the same amount of Debt, but one has Convertible Debt, and the other has traditional Debt.

Both companies have the same Operating Income, Tax Rate, and Equity Value. Which company will have a higher P / E multiple?

Convertible debt, because of the ingrained equity upside, has a lower interest rate than traditional debt. So, the company with convertible debt will have lower interest expense, and therefore higher NI. Since the numerator of both companies is the same,

Now, interest expense isn’t the only IS implication of a convertible bond, because you also have to Amortize the Convertible Bond Discount. This is an expense that will reduce NI, and make the NI of both companies a lot closer, or even the same.

A company is currently trading at 10x TEV / EBITDA. It wants to sell an Operating Asset for 2x the Asset’s EBITDA. Will that transaction increase or decrease the company’s Enterprise Value and its TEV / EBITDA multiple?

Because the company is getting rid of an operating asset, TEV will be decreasing since NOA is going down.

As far as the multiple goes, this reduces the numerator. Now, because the Asset was producing EBITDA that won’t exist going forward, the denominator is going to shrink as well. Relatively speaking, the proportion of EBITDA lost is going to be greater than the proportion of TEV lost, so the multiple is going to increase.

Is it accurate to subtract 100% of the Cash balance when moving from Equity Value to Enterprise Value?

Technically no, but in practice you almost always will subtract all of the cash. Cash is largely considered a non-operating asset, so you need to subtract it to isolate a company’s core business that runs day-to-day. But, some cash is operational to keep the lights on and things running smoothly each day. However, companies won’t break this out on the statements, and it’s likely a relatively small amount, so we just lump it all into non-operating assets for simplicity.

Why do you NOT subtract Goodwill when moving from Equity Value to Enterprise Value? The company doesn't need it to continue operating its business

Goodwill is related to the core business, though, because it reflects the premium the company was willing to pay for those past acquisitions. If you remove it, then it implies that those acquisitions no longer are a part of the company’s core business. If that is true, then they must have been sold or closed, and goodwill associated with them would have been removed.

Why do you subtract only part of a company's Deferred Tax Assets (DTAs) when calculating Enterprise Value?

Some deferred taxes arise as credits from operational items, and others are from timing differences. The one item you should be subtracting in the DTA is Net Operating Losses (NOLs) since those are non-operating. Also, like cash, they could have value to an acquirer who can potentially use them to offset pre-tax gains.

If a valuation allowance exists because a company isn’t expecting to get the full benefits of their DTA, then the NOL can be reduced proportionally.

How do you factor in Working Capital when moving from Equity Value to Enterprise Value?

Assuming we are talking about Operating Working capital, it should already be factored into the equity value under Net Assets and factored into TEV through NOA. Every line item in working capital counts under both categories.

Why do you subtract Equity Investments, AKA Associate Companies, when moving from Equity Value to Enterprise Value?

You subtract them because they are non-operating. These equity investments are not a part of the core business, the parent company cannot even control them.

The other reason is that financial metrics like EBITDA, EBIT, and Revenue only include the Parent’s financial performance even though Equity Value includes the value of the stake in the SubCo. So, by subtracting it out, you are normalizing the numerator and denominator of valuation multiples you may use, like TEV/EBITDA.

Why do you add Noncontrolling Interests (NCI) when moving from Equity Value to Enterprise Value?

Like debt or preferred stock is added, NCI also represents another investor group that has a minority stake in the SubCos of the parent.

Also, you add noncontrolling interests because, as a parent company, you exercise full control over a SubCo and integrate all of their financials with your own, including financial metrics like EBIT and EBITDA. But, your equity value doesn’t include the value of the NCI since that is outside of CSE. So, if you want apples to apples in your valuation multiples, you need to add in 100% of the SubCo value since the denominators represent a 100% inclusion of the SubCo’s financials.

Should you add on-Balance Sheet Operating Leases in the Equity Value to Enterprise Value bridge?

It depends. Under GAAP, your operating lease expense is factored into metrics like EBIT and EBITDA, so you also exclude it from TEV and Eq. Value.

Under IFRS, though, rental expense is spread on the IS between depreciation and interest expense, meaning it is added back to EBITDA and partially added back to EBIT. So, EBIT becomes a somewhat invalid metric. But, if you are using EBITDA still, then you have to also add in operating leases in the bridge for comparability purposes.

At a high level, how do Pensions factor into the Enterprise Value calculation?

You add the underfunded portion of DB Pensions, the only one on the balance sheet, since the employees paying into the plan are considered an investor group. The company gets to invest the funds put into the pension, and in exchange for the later payments, or ROI, the employees accept lower pay and benefits now.

If tax-deductible contributions are made, then you multiple the number by (1-TaxRate) in the bridge.

What is the difference between Basic Equity Value and Diluted Equity Value? What do they mean?

Basic equity values is the market cap of the company, which you find by multiplying common shares outstanding by the current share price.

But, you can also look at the diluted shares outstanding, which is the number of shares you get after factoring in dilutive securities like options, convertible bonds, warrants, and Restricted Stock units.

The difference in the two is that the Diluted Equity Value factors in eventual dilution of current shareholders, so by factoring in that dilution you get a more accurate measure of what Net Assets are truly worth to common shareholders.

A company has 100 shares outstanding, and its current share price is $10.00. It also has 10 options outstanding at an exercise price of $5.00 each. What is its Diluted Equity Value?

These options are in the money since the current share price is greater than their exercise price. Now, when exercised, there will be 110 new shares. The company gets $5 each from the 10 new shares, which is a $50 inflow in cash. With the $50 of cash, the company buys back shares to offset some of the dilution at $10 each for 5 shares. Meaning, there are now only 105 shares at $10 each, which leaves Diluted Equity Value at $1050

A company has 1 million shares outstanding, and its current share price is $100.00. It also has $10 million of convertible bonds, with a par value of $1,000 and a conversion price of $50.00.

What are its diluted shares outstanding and Diluted Equity Value?

Share price exceeds conversion price, so we calculate the amount of shares that would be created if the bonds were converted into shares. Since the value of the bonds is $10M and the conversion price is $50, 200,000 shares will be created.

So, the diluted shares outstanding are 1.2M, and the diluted equity value is $120M

A company has 10,000 shares outstanding and a current share price of $20.00. It has 100 options outstanding at an exercise price of $10.00.

It also has 50 Restricted Stock Units (RSUs) outstanding.

Finally, it also has 100 convertible bonds outstanding at a conversion price of $10.00 and par value of $100.

What is its Diluted Equity Value?

Starting with the RSUs vesting, this would create 50 new common shares. Then, we can act as if the in-the-money options get exercised, which is another 100 shares, this time at $10 each, which generates $1000 in proceeds for the company, who will then try to offset some dilution by buying back shares. At the current market price of $20, this buys back 50 shares. So, between the RSU and options, 100 new shares have become outstanding. Now for the convertible bond, with the stock price being above the conversion price of $10, at $100 of par, 10 new shares are created for each outstanding convertible bond, which is 1000 new shares total. Paired with the RSUs and options, this brings you total share count up to 11,100, which at $20 per share creates a diluted equity value of $222,000

A company with an equity value of $222,000 has cash of $10,000, Debt of $30,000, and Noncontrolling Interests of $15,000. What is its Enterprise Value?

To make the bridge from equity value to enterprise value, you need to add other investor groups like NCI and debt, and subtract nonoperating assets like cash.

So, you start with $222,000, add $30000 from debt and $15000 from NCI, and subtract $10,000 from cash, giving you an enterprise value of $257,000.

A company issued a convertible bond in a “capped call” transaction where it also purchased call options on its own stock at an exercise price equal to the conversion price and sold warrants on its stock at a higher exercise price.

How would you estimate the dilution in this case?

When a company issues a convertible bond, it typically also purchases call options (a "capped call") as a hedge. These call options are structured to offset all of the initial dilution that would otherwise come from the convertible bond. In other words, new shares get created upon conversion, but the company then exercises its call options to repurchase an equivalent number of shares, effectively neutralizing that dilution.

At the same time, the company usually sells warrants with a higher strike price — for example, $100, if the bond's conversion price is $60 or $70. These warrants are accounted for separately using the Treasury Stock Method (TSM).

Putting it together: if the company's current share price is $40, there's no net dilution from the convertible bond because the capped call offsets it completely. Dilution only begins to show up once the share price rises above $100, the warrant strike price — at which point you'd apply the TSM to calculate the incremental dilution from the warrants.

One caveat: this clean offsetting logic assumes the number of call options purchased exactly matches the number of potentially dilutive shares from the convertible bond. In practice, the company might buy a different quantity — say, 1,000 call options against 1,100 or 1,200 potentially dilutive shares — which would leave some residual dilution even below the warrant strike price. So this framework is a simplification, but it captures the core mechanics of how capped calls are meant to work.

Does debt add to enterprise value? And does cash reduce it because it’s the opposite of debt?

Debt does not “add to” enterprise value in the sense that issuing debt would increase a firms enterprise value. On the contrary, you add debt to the bridge to get to enterprise value.

The cash thing is a misconception as well. Cash is not the “opposite of debt” because having more cash doesn’t just offset debt. And, even if you wanted it to by repaying down debt right away, a lot of bond contracts won’t even allow for full upfront payment, so the framework is technically infeasible too.

What opportunity does a negative EV present for investors.

If the EV of a company is negative, it means that the value of the company’s non-operating assets are greater than the value of all the investor groups put together. So, you are effectively buying dollars for a discount. But, since this situation is mostly present in very distressed situations, there’s a significant risk involved.

Does the Preferred Stock line change when a company pays Preferred Dividends?

No, because you aren’t retiring or paying back shares or anything, you are just paying out a dividend from NI before NI to Common. This reduces cash and CSE only.

Why is Debt "cheaper" than Equity — and why does capital structure still move WACC?

Debt is a cheaper cost of financing for a company because debt investors expect lower returns in exchange for protections like being higher on the capital stack and having claims on assets first. The interest expense associated with debt also provides a tax shield to the company. Capital structure still moves WACC, an consequently valuation, because as a company uses more debt, their cost of capital first decreases, but then it reaches a point where leverage has gotten so high that the interest payments and eventual maturity of that debt presents a significant risk to investors, so they will demand a higher return to compensate.

Why won't a company with negative Net Income list its Diluted Shares?

Well if you have negative earnings but more shares because of dilution, that loss gets spread across more investors and EPS actually becomes higher. Since this is anti-dilutive to the EPS number, companies can’t report it.

Three dilutive-security nuances that trip people up

a) Restricted Stock is usually already in the share count → ignore; RSUs are not → add them.

(b) Performance Shares / SARs — add all or ignore all (goals undisclosed); adding all is the conservative choice (higher count → lower implied share price).

(c) Only options the *company grants employees* create new shares — never count market-traded options on already-existing shares.

Why is Stock-Based Compensation NOT added back in Unlevered FCF, even though it's non-cash?

Even though it isn’t a cash expense, it is still dilutive, meaning it destroys value for investors

Which part of the Pension Expense belongs in EBIT/EBITDA?

The only operational part of the Pension Expense is the service cost, so you include that.

Capital vs Operating Leases in EV — the always-true rules.

Finance leases always get added back to the bridge as deb-like, same with operating leases under IFRS.

When calculating ROIC, if you count Operating Leases as invested capital, then you have to make sure to add back their interest element into EBIT before calculating NOPAT for comparability.

How are goodwill/intangibles, DTLs, and Provision/Other Liabilities treated in the EV bridge?

Goodwill/intangibles are operating, so they are not included. DTLs are caused largely by operational timing differences, so they are also included, plus you don’t know when they will begin to reverse. Provision/Other Liabilities should be examined for debt-like elements or components of an underfunded pension, which would be added as another investor group.

How does a Valuation Allowance change the NOL you put in the bridge?

A valuation allowance is created when a company doesn’t think it will ever realize the full benefit of any DTAs it has, no you need to reduce NOLs proportionally by doing:

NOL * (1- (Valuation Allowance/Total DTA))

Why are forward multiples lower than historical?

Because the denominator of the multiple grows while the numerator stays the same

Walk me through the five dimensions on which Revenue, EBIT, EBITDA, EBITDAR, and Net Income differ.

• To Whom Available:

  • Revenue → EBITDAR: Available to all capital providers + government (nobody has been paid yet).

  • Net Income: Equity-holders only (debt paid via interest, government via taxes, preferred via dividends).

• OpEx vs. CapEx:

  • Revenue: Reflects neither.

  • EBIT & Net Income: Includes OpEx + CapEx after-effects (Depreciation & Amortization).

  • EBITDA / EBITDAR: Includes OpEx, excludes CapEx entirely.

• Rent / Lease Expenses:

  • Varies by metric and accounting standard (US GAAP vs. IFRS).

• Interest, Taxes, and Non-Core Items:

  • Revenue → EBITDAR: Ignores all non-operating items.

  • Net Income: Deducts net interest and taxes, and nets out non-operating items.

• When Useful & Valuation Pairing:

  • Revenue: Early-stage / negative-EBITDA companies.

  • EBIT: CapEx-heavy businesses where asset aging drives value.

  • EBITDA: Normalizing across different CapEx levels and capital structures.

  • EBITDAR: Comparing companies with different lease structures or across US GAAP / IFRS.

  • Net Income: Quick sanity check (pairs with Equity Value; all others pair with Enterprise Value).

Under US GAAP vs. IFRS, how is Rent/Lease Expense treated in each core metric — and what does that do to valuation multiples?

• Revenue: Excludes lease expenses under both systems.

• EBIT:

  • US GAAP: Full deduction (operating expense).

  • IFRS: Deducts only the depreciation portion (interest sits below operating income) → EBIT is invalid under IFRS without adjustment.

• EBITDA:

  • US GAAP: Full deduction (operating expense).

  • IFRS: Deducts nothing (both depreciation and interest are excluded).

• EBITDAR: Deducts nothing under either system (EBITDAR = EBITDA under IFRS).

• Net Income: Full deduction under both systems.

Multiple Pairing Rules:

If a denominator excludes lease expense, the numerator must add Operating Lease Liabilities:

• IFRS: Pair EBITDA with TEV Including Operating Leases.

• US GAAP: Pair EBITDA/EBIT with Standard TEV (or use EBITDAR with TEV Including Operating Leases).

Walk me through the three rules for pairing a metric with Equity Value vs. Enterprise Value

• Rule 1 — The Net Interest Test (The Funnel):

  • As you move down the Income Statement, investor groups drop out once paid.

  • If a metric deducts net interest (and preferred dividends), only equity investors remain → Pair with Equity Value.

  • If it does not deduct interest, all capital providers are still included → Pair with Enterprise Value (EV).

• Rule 2 — Numerator/Denominator Correspondence:

  • If the denominator excludes or adds back an Income Statement expense, the numerator must add the corresponding Balance Sheet liability.

  • EBITDA excludes interest → Add Debt

  • EBITDAR excludes rent → Add Operating Lease Liabilities

  • Excludes preferred dividends → Add Preferred Stock

• Rule 3 — No "Half-Pregnant" Multiples:

  • Stick strictly to standard Equity Value or Enterprise Value. Do not create hybrid numerators (e.g., Equity Value + Preferred Stock paired with plain Net Income).

  • The only accepted variation is TEV Including vs. Excluding Operating Leases.

Which sectors use non-standard valuation approaches, and how do they differ from standard metrics?

• FIG (Banks & Insurance):

  • Enterprise Value is invalid because operating assets/liabilities cannot be separated from financial assets/liabilities (a loan is core operation for a bank).

  • Use P/E, P/BV, P/TBV, the Dividend Discount Model (DDM), and Embedded Value (for life insurance).

• Real Estate / REITs:

  • Use FFO (Net Income + D&A − Gains/Losses) instead of Net Income → Multiple: Equity Value / FFO.

  • AFFO deducts recurring maintenance CapEx. NAV models value individual properties.

• Oil & Gas:

  • EBITDAX (EBITDA + Exploration Expense) to eliminate accounting differences.

  • Production multiples: TEV / Proved Reserves and TEV / Daily Production.

  • Midstream MLPs use Distributable Cash Flow (DCF).

• Metals & Mining:

  • TEV / Reserves & Production and long-term NAV models (mine-by-mine life model, no terminal value).

• Airlines:

  • TEV Incl. Operating Leases / EBITDAR (normalizes owned vs. leased aircraft).

  • Operational metrics: RASM, Load Factor, and RPM.

• Pre-Revenue Tech / Media:

  • Non-financial usage metrics (MAU, Subscribers, Unique Visitors, ARPU) paired with Enterprise Value.

Explain why Enterprise Value is NOT truly capital-structure-neutral in real life (the Modigliani-Miller breakdown)

In theory (Modigliani-Miller), capital structure changes do not alter Enterprise Value — only Net Operating Assets do. In reality, capital structure shifts WACC, which changes Implied Enterprise Value:

• Why WACC Changes:

  1. Adding some Debt initially lowers WACC (Debt is cheaper due to fixed returns and tax deductibility).

  2. Past an optimal point, excess Debt raises default/bankruptcy risk, driving up both the Cost of Debt and Cost of Equity.

• The 4 Real-World Drivers:

  1. Tax Shield Benefits

  2. Financial Distress & Bankruptcy Costs

  3. Agency Costs (conflict between debt/equity holders)

  4. Market Imperfections / Asymmetric Information

• Key Takeaway:

  EV is far less affected by capital structure than Equity Value, but it is not completely immune

How do the post-2019 lease accounting rules (ASC 842 / IFRS 16) affect valuation metrics under US GAAP vs. IFRS?

Operating leases are now brought onto the Balance Sheet as a Right-of-Use (ROU) Asset and a Lease Liability. The key valuation impact lies in how the expense is treated on the Income Statement:

• US GAAP (Single Expense Treatment):

  • Keeps rent as a single operating expense.

  • EBIT and EBITDA both fully deduct rent.

  • Valuation: Use standard TEV (excluding Operating Leases) paired with EBIT/EBITDA, or use EBITDAR paired with TEV Including Operating Leases.

• IFRS (Split Expense Treatment):

  • Splits rent into Depreciation (ROU Asset) + Interest Expense.

  • EBITDA excludes both → You MUST add Operating Leases to TEV.

  • EBIT excludes interest → Invalid unless adjusted.

• Universal Rules:

  1. Finance / Capital Leases are always treated as Debt under both standards.

  2. Net Income and Net Cash Flow remain largely unchanged (it is mostly a cosmetic reclassification).

  3. In ROIC, if Operating Leases are included in Invested Capital, NOPAT must add back the interest component.