Equity Value vs. Enterprise Value and Valuation Multiples

Learn how Equity Value and Enterprise Value change when a company issues debt, pays off debt, issues equity, and repurchases shares.
By http://breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
The key point is that regardless of how a company is financed, its Enterprise Value - and Enterprise Value-based multiples - do NOT change. Equity Value, however, may change depending on its share count and any shares it issues or repurchases.

So even when a company changes its debt or equity or cash levels, valuation multiples such as EV / EBITDA and EV / Revenue will not change immediately afterward... whereas a multiple such as P / E (Price Per Share / Earnings Per Share, or Equity Value / Net Income) will change if new equity has been issued.

It's just like when you buy a house - house is worth $500K regardless of whether you pay with 100% cash or 50% cash and 50% debt, or anything else in between... but depending on how much cash and debt you use, your own EQUITY IN THAT HOUSE will be different.

The $500K total value of the house is like the Enterprise Value for a company.

And if you contribute $250K of your own cash and take on a $250K mortgage, the $250K you chip in is your "Equity Value" and the $250K mortgage is the "Debt."

Over time, your own "Equity Value" in that house will increase and your own "Debt" will decrease as you repay the mortgage, but the $500K total value for the house stays the same as long as the house's intrinsic value remains the same.

This example uses Coca-Cola's filings and financial statements - you can find them and try this yourself right here:

http://www.coca-colacompany.com/investors/annual-other-reports
http://www.coca-colacompany.com/investors/investors-info-quarterly-filings

(NOTE: The numbers, of course, will be different if you look at this video at a later date, but the concept remains the same and has always been the same ever since Equity Value and Enterprise Value were invented.)

MENTIONED RESOURCES
http://youtube-breakingintowallstreet-com.s3.amazonaws.com/KO-Equity-Value-Enterprise-Value.xlsx

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Closed Caption:

yeah
hello and welcome to our lesson on
equity value and enterprise value now in
this lesson I'm not going to go over the
basic definitions of equity value and
enterprise value will see down here that
i have an example of the actual
calculation for coca-cola that's the
company were using in our example here
i'm not going to go over the basic
definition instead what I want to focus
on is how equity value and enterprise
value change when the company's
financing method changes i'm going to
zoom in a little bit you can see this
part up here at the top a little bit
better and really the key point of this
lesson is that no matter how companies
financed its enterprise value stays the
same but its equity value may change
depending on the mix of equity debt and
cash
what this means is that if you have
evaluation multiple like enterprise
value to even ah well that's not going
to change immediately after their
financing mix changes even if it's
significantly different at least on
historical basis one analogy that's
often used to explain this concept is
that lets you buy a house for $500,000
well that house is worth $500,000
regardless of whether you pay for it
with a hundred percent cash or fifty
percent cash 50-percent debt or eighty
percent debt and twenty percent cash it
doesn't matter what the mix to finance
your purchase is all that matters is
what the house is worth $MONEY on an
absolute basis and it's really the same
thing with companies as well see below
now this example as i mentioned before
we're using coca-cola if you're
wondering where i got some of these
numbers from in our basic calculations
here for equity value enterprise value
you can just follow the links on screen
above or search for coca-cola investor
relations and what I've done to save us
some time is already pulled a number
from their most recent balance sheet
here and I've got some of the numbers
from their annual statements as well for
the trailing-twelve-month numbers
specifically so you can go to get these
yourself if you're looking at this video
at a later date of course these numbers
will be different but that is where all
of them are coming from in the first
place
and then one final note here this lesson
is really more about the concept and how
to answer interview questions so of
course if a company actually pays off
debt or raises additional equity the
market is probably have some type of
reaction to that in the intermediate to
long-term we're ignoring that here we're
saying strictly on the counting basis
what happens
how does the company's balance sheet
change after this and how does that
impact the equity value enterprise value
so that's one thing to keep my here now
the basic definition i'm not going to go
through detail because we're not focus
on in this lesson but essentially equity
value just the current share price times
the shares outstanding can be diluted or
basic we're using diluted shares here
and then to get to enterprise value
essentially you are subtracting any cash
like items so anything that can acquire
of the company buyer the company could
take for themselves and use in the form
of cash or subtracting those and then
we're adding in any types of debt or
debt-like obligations that cannot be
paid out of a company's normal business
operating cash flows so in that category
a couple items will be debt unfunded
pension obligations non-controlling
interest that's a bit of a different
category we're adding this back for
comparability purposes but look at that
in a later lesson we're not really
focused on this basic definition for now
in any case we subtract the cat those
cash like items we add the debt like
items and other obligations to get to
our enterprise value i also have here
some of cockles financial data for
revenue da earnings before interest
taxes depreciation amortization and net
income and I have some of the key
multiple so enterprise value to revenue
enterprise value to eat aa and then PE
so price-to-earnings or equity value to
net income so the question now is what
happens how does this change if
coca-cola issue shares what happens if
they raise debt over here and then what
happens if they repurchase shares over
here and then finally what happens if
they repay some of their debt so if they
take some that 35 billion worth of debt
and repay say 10 billion worth it
so let's go through the scenarios one by
one I'm gonna show you what happens with
equity value enterprise value in
multiples each time so first off what if
the issue 10 billion dollars worth of
shares well their equity goes up by 10
billion because it's
a value of the shares issued and their
cash also goes up by 10 billion so what
happens here while our equity value goes
up you can see this highlighted in red
but our cash also goes up and so what
that means is that the enterprise value
stays the same so take a look at this
these two enterprise value based
multiples revenue and even ah those say
the same however the historical p/e
multiple changes because our equity
value is now different so as you can see
here even if the issue shares enterprise
value stays the same because the market
is not going to value a company more
highly just because they have additional
shares outstanding the company is worth
what it's worth based on its financial
performance and the markets of use of it
and future expectations it's not going
to go up or down in value just because
it happens issue more shares or
otherwise change its method of financing
so let's look at scenario number two now
which is what happens if it raises 10
billion dollars worth of debt
what happens here while our debt goes up
by 10 billion someone enter that right
there and then our cash also goes up by
10 billion because remember he raise
debt on the other side of the balance
sheet your cash goes up because you're
getting cash from that debt you raise
what happens here while our cash and
cash equivalents go up by 10 billion
once again our debt goes up by 10
billion as well and those changes
essentially cancel each other out
we're subtracting a greater negative 4
also adding a greater positive to get to
our enterprise value and what happens
again enterprise value stays the same
equity value actually stays the same in
this case as well least from an
accounting perspective and all of our
valuation multiples stay the same in
this case so this is one case where
neither equity value nor enterprise
value actually change now Sarah number
three here what happens if coca-cola
repurchases 10 billion worth of shares
so in this case our cash balance is
going to go down because we're
presumably using some cast repurchase
shares and our equity is also going to
go down because the shares no longer
exists
they've been removed from the market
what happens here well our equity
changes by negative 10 billion and then
our cash also changed by negative 10
billion
and so what happens here is that our
equity value goes down because we
repurchased shares but our enterprise
value once again stays the same our
enterprise value based multiples here
also stay the same and historical p/e
multiple changes because our equity
value is now different that's what
happens when we repurchased shares
interesting enough in this scenario even
if we were to use debt to repurchase
shares the same thing would happen
although it happens instead of cash
decreasing by 10 billion debt would
increase by 10 billion so let's plug in
that scenario and see what happens here
and you see it again
equity value goes down but debt goes up
and as a result our enterprise value
stays the same multiple stay the same
and the equity value based multiple PE
changes to change this back for now and
then finally to scenario for which is
what happens when we repay 10 billion
worth of get so I've grouped some of
these columns you can see this a little
bit more effectively on screen so we
repay 10 billion dollars worth of debt
while our debt is going to decrease by
10 billion and in a lot of cases will
pay for that with cash so our cash is
also going to decrease by 10 billion so
what happens in this case our equity
value stays the same because we're not
changing our share count or number of
shares or share price or anything like
that and then our enterprise value also
stays the same because we are
subtracting less of a negative in terms
of the cash but we're also adding less
debt because we repeat some of it are
multiples all stay the same in this case
now even if we were to do this even if
we were to repay the debt by raising
additional equity same thing would
happen
let's take a look at this let's enter 0
for cash and then let's enter 10 billion
worth of equity series equity issue
shares to use to repay debt and in this
case of course for equity value is up
but our debt goes down and so our
enterprise value stays the same our
enterprise value based multiple stay the
same and our PE multiple changes so
bottom line regardless of how we repay
debt how we finance it
our enterprise value and enterprise
value based multiples are going to stay
the same no matter what happens there so
key takeaways from this
regardless of whether you raise debt or
equity or you pay off debt repurchase
shares enterprise value does not change
and neither do the enterprise value
based multiples such as enterprise value
to revenue and ebitda earnings before
interest taxes depreciation and
amortization now in the long term or
even in the intermediate term by doing
these things you are sending signals to
the market the market may respond and so
the share price of the company may
change as a result enterprise value may
indeed end up changing but these
scenarios are more about how to answer
interview questions and about the basic
concepts equity value equity value based
multiples will change often based on the
financing differences and how you
finance these types of changes whether
you use cash or equity or debt and so
this is really yet another reason why
enterprise value and enterprise value
based multiples are so important because
it let's you evaluate a company on a
capital structure neutral basis and say
regardless of how this company's finding
itself
what is it worth
yeah
yeah