The Age‐old Question: Enterprise Value or Equity Value?

I’m not sure it’s always this clear, but I’ll throw it on the blog to see if it sticks. I found this comment somewhere, and I like its clarity. From a valuation perspective, equity value depends on enterprise value, not the other way around. That is, one should first determine enterprise value without knowing equity value. Enterprise value can be determined from the operations of the company. Calculating enterprise value after knowing equity value violates Modigliani and Miller, which states in part “the market value of the firm – debt plus equity – depends only on the income stream generated by its assets.” In other words, the enterprise value of a firm is the present value of expected future cash flows. From these projections, equity value can be derived through several adjustments.

In the interest of keeping it simple, stupid, here’s the calculation: Enterprise Value = Market Cap + Market Value of Debt + Minority Interest ‐ Associate Company + Preferred Equity ‐ Cash and Cash Equivalents. This represents the value an acquirer would be willing to pay for a firm—it could pocket the cash but would also have to take on the market value of debt. Equity value, however, represents the value of shareholders’ claims on the assets and cash flows of the firm. All in all, enterprise value provides a more comprehensive look at the firm by including all forms of capital.

The difference between these two perspectives is important for valuation specialists to understand because it ensures the analysis of a firm is done consistently and accurately.

By |2018-06-20T18:57:05+00:00August 1st, 2010|Valuation|Comments Off on The Age‐old Question: Enterprise Value or Equity Value?