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Key Formulas
Basic Equity Value = Common Shares Outstanding * Share Price
Diluted Equity Value = Diluted Shares Outstanding * Share Price
Dilution from Options = # Options – (# Options * Exercise Price) / Share Price
Dilution from Convertibles = # Convertible Bonds * Conversion Ratio
Enterprise Value = Equity Value – Cash + Debt + Minority Interest + Preferred Stock
For the dilution calculations above, the exercise price or conversion price needs to be below the share price –
otherwise you will get no dilution. You can’t exercise options and you can’t convert convertibles into shares
otherwise.
Equity Value vs. Enterprise Value
Equity Value : Enterprise Value :: List Price of House : True Cost of House
Equity Value tells you at a glance how much a company is worth – whereas
Enterprise Value tells you more accurately how much it would really cost to
acquire the company.
When you buy a house, there are all sorts of hidden costs like required
repairs, unpaid bills, obligations, and more – but you might also benefit
from, for example, getting furniture for free with the house.
Enterprise Value works the same way: it takes into account the obligations
that you need to repay, like debt, and also the “free gifts” you get, like cash,
and gives you the true cost to acquire a company.
Cash
Think of Cash as a “free gift” when you buy a company – it reduces your
effective price because you get the target’s entire Balance Sheet as part of the
acquisition.
How You Factor Cash Into Enterprise Value: Subtract it.
You almost always include Short‐Term Investments as part of the Cash
number, but Long‐Term Investments depend on the liquidity and what
your bank usually does.
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Debt
Debt refers to loans that a company has taken out. Normally when you buy
a company, you’re required to refinance its debt, so it’s counted as one of
those “hidden costs” to make an acquisition.
How You Factor Debt Into Enterprise Value: Add it.
All debt‐related items should be counted in this number – short‐term debt,
long‐term debt, revolvers, mezzanine, and so on. The only exception:
convertible bonds, which may or may not be counted (see below).
It’s better to use market values for debt, but if you don’t have them you can
just use what’s listed on the Balance Sheet (book values).
Minority Interest
When you own more than 50% of another company, Minority Interest
refers to the percent that you DON’T own. You need to add it back to
Enterprise Value because the other company’s revenue and profit are
included in your own financial statements – so you need to make sure
its value is reflected in EV as well.
How You Factor Minority Interest Into Enterprise Value: Add it.
Minority Interest is listed on the Balance Sheet, under Liabilities or
Shareholders’ Equity – in most cases you’re fine listing what’s in the
filing, but if you have market numbers you can use them.
Preferred Stock
Preferred Stock is very similar to Debt – investors receive a guaranteed
dividend, usually in the form of an interest rate on the Preferred Stock
balance.
How You Factor Preferred Stock Into Enterprise Value: Add it.
Preferred Stock is listed on the Liabilities & Shareholders’ Equity side of the
Balance Sheet.
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Treasury Stock Method
You use the Treasury Stock Method to calculate dilution – new shares being created – from options
outstanding.
You assume that any in‐the‐money options turn into shares, the company gets paid for this, and that they then
use the funds to repurchase some of the newly created shares.
Dilution from Options = # Options – (# Options * Exercise Price) / Share Price
You can find the necessary information – option tranches, number of options, and the exercise prices by doing
a search for “Exercise Price” in a company’s annual or quarterly filings.
Convertible Bonds
Dilution from Convertibles = # Convertible Bonds * Conversion Ratio
# Convertible Bonds = Convertible Dollar Amount / Par Value
Conversion Ratio = Par Value / Conversion Price
Conversion Price = Par Value / Conversion Ratio
As with options, you only get dilution from convertible bonds if the company’s current share price exceeds the
conversion price of the bonds. Normally you assume $1,000 for the Par Value.
How You Factor Convertible Bonds Into Enterprise Value: If the convertible bonds are in‐the‐money (they
can convert to shares) then you calculate the dilution and add them to shares outstanding. If they’re out‐of‐
the‐money (they cannot convert into shares) then you count the bonds as debt instead.
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Enterprise Value Advanced Additions
There are several other items you may need to add or subtract from Equity Value to get to Enterprise Value.
How much time you spend on these depends on the company you’re analyzing and how your group works –
some places like to spend time on these details, while other bankers don’t care that much.
Equity Investments
Equity Investments represent cases where our company owns LESS than
50% of another company. They’re the opposite of Minority Interest.
Since you could theoretically go and sell Equity Investments for cash, and
since these companies’ financials do NOT show up in our own, we count
them as a cash‐like item.
How You Factor Equity Investments Into Enterprise Value: Subtract them.
In addition, you may apply a discount rate to Equity Investments and make
other adjustments to reflect their relative illiquidity.
Net Operating Losses (NOLs)
When a company is not profitable – it has a negative Pre‐Tax Income –
over time it accrues “Net Operating Losses,” which are credits that can
be used to offset future tax payments.
If we go to buy a company, we can use its NOLs to offset our own Pre‐
Tax Income and reduce our tax burden, so they’re a “free gift.”
How You Factor NOLs Into Enterprise Value: Subtract them.
You can find Net Operating Losses in a company’s annual report by
doing a search for the term – it’s not as simple as just adding the dollar
amount, though, as you need to calculate how much the acquirer
would actually save in taxes.
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Capital Leases
When a company rents an office or building and has no intent of ever owning it in the future, that’s just a
normal operating lease: the rent shows up as an Operating Expense and there’s no Interest Expense or
Depreciation.
With capital leases, by contrast, there’s an element of ownership as well as an Interest / Depreciation expense
associated with leasing the asset and then eventually owning it.
Capital Leases should be added to a company’s Equity Value to get to Enterprise Value, but sometimes you
need to count operating leases as capital leases… if any of the 4 following conditions is true:
1. If there’s a transfer of ownership at the end of the term.
2. If there’s an option to purchase the asset at a bargain price at the end of the term.
3. If the term of the lease is greater than 75% of the useful life of the asset.
4. If the present value of the lease payments is greater than 90% of the asset’s fair market value.
Most of the time, the only condition you have enough information to check on is #4 – so you could go through
a company’s filings and do an NPV calculation to assess this one:
The problem, though, is that we have no idea what our asset’s “fair market value” is – we would need to speak
with the CFO or with accountants to get a sense of that.
Similarly, we rarely have enough information to check whether conditions 1 through 3 above are true – a
company’s filings just don’t give enough detail on what’s included in leases.
Most of the time, we normalize companies’ financials for rental expenses by using EBITDAR (Earnings Before
Interest, Taxes, Depreciation, Amortization, and Rent) rather than EBITDA.
I’ve shown you this example in the interest of completeness, but in the real world you rarely attempt to
convert operating leases into capital leases – you just don’t have enough information.
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Pension Obligations
Pension Obligations represent how much a company owes to retiring
employees.
Similar to Debt or any other significant obligations, you add these back
because an acquirer often has to pay them, especially if they’re unfunded
(e.g. the company has not set aside money to pay for them yet).
How You Factor Pension Obligations Into Enterprise Value: Add them.
You should only add the unfunded portion of these pension obligations.
You can find information on these obligations in a company’s 10‐K or 10‐Q.
Other Obligations
There are a wide variety of Other Obligations that you may also need
to add to the Enterprise Value:
Environmental Liabilities
Future Restructuring Costs
Abandonment Provisions
How You Factor Other Obligations Into Enterprise Value: Add them.
Basically anything that an acquirer would have to pay for and anything
that reflects a claim on a company’s assets should fall under this
category.
Sometimes you have to dig through filings to find this information –
how much time you spend looking for them depends on the company,
industry, and how detail‐oriented your group is.