How to calculate Enterprise Value

What is financial modelling

Enterprise value represents the true value of acquiring the company. It is the total value of equity and Net debt.

Enterprise Value can be calculated in two ways.

  1. DCF valuation method which is based on fundaments of company (Not covered in this Article)
  2. Market price which is a market factor

Let's look at the formula for Enterprise Value:

Enterprise Value = Equity Value + Total Debt + Preferred Stock + Minority Interest + Capital Lease – Cash & Equity

Enterprise value is the theoretical price the acquirer will pay to another company based on current market price. Let’s look at various components of Enterprise value formula.

Equity Value:

Equity Value or Market capitalization represents the market value of company’s common equity which is calculated with the following formula.

Equity Value = Diluted Shares Outstanding * Market Price

Where Diluted Shares Outstanding = Basic Shares Outstanding + Dilutions (Dilution comes from diluted securities)

Diluted securities are those securities which can be converted into Common Equity and reduce EPS by increasing the shares outstanding. Dilutive securities are Option, Warrant, Convertible preferred Stock and Convertible debt.

Basic Shares outstanding can be taken from latest company files whichever is available on the day of valuation and Add to that number any restricted shares and net shares resulting from the exercise or conversion of options, warrants, and convertible securities to get diluted shares outstanding.

“Treasury stock method” is used to calculate dilution from Options & warrants and “IfConverted method”is used for Convertible debt & preferred stock.

“Treasury stock method”assumescash received from exercise of options will be used to repurchase the shares at market price.

  • Net share equivalents = options − (options × exercise price ÷ current market price)
  • Includes all outstanding in-the-money (ITM) options, whether vested or not

Convertible debt or convertible preferred stock, are convertible into common shares at a specific stock price known as the conversion price or strike price or exercise price. Only in-the-money (ITM) convertible securities where SP < MP can be converted in common equity.

If the current stock price is greater than the conversion price, the convertibles are ITM

ITM convertible securities increase the number of shares outstanding by the amount of new shares issued upon conversion

New shares issued = face value of ITM convertibles ÷ conversion price (also known as Strike Price)

If Convertible debt or convertible Preferred stock are ITM and converted in common equity and they will be reduced from debt and dilution will be added in shares.

Net Debt

Net debt is equal to total debt less cash and cash equivalents.

Net Debt = Total Debt (STD+LTD) – cash & cash equivalent

The market value of debt should be used in the calculation of enterprise value if it is available else take the book value of debt from Balance Sheet.

Any in-the-money (ITM) convertible debt is treated as equity and is not considered debt. So that debt which has been converted into common equity while calculating dilution will be deducted from Total debt because that converted debt is not debt any more, it would have been included into equity.

Cash and equivalents will include all short term and long term “Available for Sale Securities” and “Marketable Securities”. Do not include restricted cash in this calculation. We generally ignore restricted cash unless it is explicitly identified on the balance sheet or elsewhere in company filings.

Noncontrolling (Minority) Interest:

Noncontrolling Interest or Minority interest represents the equity value in a subsidiary company which is not owned by parent company.

For example, a parent company might have an 80% controlling equity stake in a consolidated subsidiary, while the remaining 20% noncontrolling equity stake is owned by another company. That 20% equity value which is not owned by parent company is Minority Interest. I hope this clears concept.

Preferred Stock:

Non-convertible Preferred Stock or Out of Money Convertible preferred stock will be added to enterprise value. Preferred stock value can be taken from Balance Sheet under equity section.

Capital Lease:

Capital Lease is generally included in long term debt. So Capital lease value is already there in the EV calculation through Long term debt.

Best of luck.

Manoj Kumar

Senior Faculty

Investment Banking Institute

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