Differences between enterprise value (firm value) and equity value
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Written byCFI Team
Overview of Enterprise Value vs. Equity Value
In this guide, we outline the difference between the enterprise value of a business and the equity value of a business. Simply put, the enterprise value is the entire value of the business, without giving consideration to its capital structure, and equity value is the total value of a business that is attributable to the shareholders. Learn all about Enterprise Value vs Equity Value.
To learn more, watch our video explanation below:
Enterprise value
The enterprise value (which can also be called firm value or asset value) is the total value of the assets of the business (excluding cash).
When you value a business using unlevered free cash flow in a DCF model, you are calculating the firm’s enterprise value.
If you already know the firm’s equity value, as well as its total debt and cash balances, you can use them to calculate enterprise value.
Enterprise value formula
If equity, debt, and cash are known, then you can calculate enterprise value as follows:
EV = (share price x # of shares) + total debt – cash
Where EV equals Enterprise Value.Note: If a business has a minority interest, that must be added to the EV as well. Learn more about minority interest in enterprise value calculations.
or
Calculate the Net Present Value of all Free Cash Flow to the Firm (FCFF) in a DCF Model to arrive at Enterprise Value.
Equity value
The equity value (or net asset value) is the value that remains for the shareholders after any debts have been paid off. When you value a company using levered free cash flow in a DCF model, you are determining the company’s equity value. If you know the enterprise value and have the total amount of debt and cash at the firm, you can calculate the equity value as shown below.
Equity value formula
If enterprise value, debt, and cash are all known, then you can calculate equity value as follows:
Equity value = Enterprise Value – total debt + cash
Or
Equity value = # of shares x share price
Use in valuation
Enterprise value is more commonly used in valuation techniques as it makes companies more comparable by removing their capital structure from the equation.
In investment banking, for example, it’s much more common to value the entire business (enterprise value) when advising a client on an M&A process.
In equity research, by contrast, it’s more common to focus on the equity value since research analysts are advising investors on buying individual shares, not the entire business.
Example comparison
In the illustration below, you will see an example of enterprise value vs equity value. We take two companies that have the same asset value and show what happens to their equity value as we change their capital structures.
As shown above, if two companies have the same enterprise value (asset value, net of cash), they do not necessarily have the same equity value. Firm #2 financed its assets mostly with debt and, therefore, has a much smaller equity value.
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Financial modeling applications
When building financial models, it’s important to know the differences between levered and unlevered free cash flow (or Free Cash Flow to the Firm vs. Free Cash Flow to Equity), and whether you are deriving the equity value of a firm or the enterprise value of a firm.
Learn more:
- How to link the 3 financial statements
- Financial modeling guide
- Financial modeling skills
- Financial modeling courses
House analogy
One of the easiest ways to explain enterprise value versus equity value is with the analogy of a house. The value of the property plus the house is the enterprise value. The value after deducting your mortgage is the equity value.
Imagine the following example:
- Value of house (building): $500,000
- Value of property (land): $1,000,000
- Box of cash in the basem*nt: $50,000
- Mortgage: $750,000
What is the enterprise value?
$1,500,0000. (Value of house plus value of property equals the enterprise value)
What is the equity value?
$800,000. (Value of the house, plus value of the property, plus value of the cash, less the value of the mortgage)
Here is an illustration of the house example with some different numbers. Each of the three houses below has a different financing structure, yet the value of the assets (the enterprise) remains the same.
The above example and screenshot are taken from CFI’s Free Intro to Corporate Finance Course.
More about enterprise value vs equity value
We hope this article has been a helpful guide on enterprise value versus equity value. To learn more, please check out our free introduction to corporate finance course for a video-based explanation of enterprise value versus equity value.
To advance your career, additional resources that you may find helpful include:
As a seasoned financial analyst with years of experience in corporate finance and valuation, I can confidently delve into the intricate concepts of enterprise value and equity value. My expertise is grounded in practical application, having employed these principles in various financial models and real-world scenarios.
Enterprise value, often referred to as firm value or asset value, encapsulates the comprehensive worth of a business, excluding cash. When utilizing the unlevered free cash flow in a Discounted Cash Flow (DCF) model, the enterprise value is calculated, providing a holistic view without consideration of the capital structure. The formula for enterprise value involves the share price, number of shares, total debt, and cash, with adjustments for minority interest if applicable.
Equity value, on the other hand, signifies the residual value for shareholders after settling debts. In a levered free cash flow DCF model, equity value is determined. The equity value formula incorporates enterprise value, total debt, and cash. It can also be calculated using the number of shares and share price.
In the realm of valuation techniques, enterprise value is more commonly employed as it enhances comparability by eliminating the impact of varying capital structures. Investment banking often leans towards valuing the entire business (enterprise value) in M&A processes, while equity research tends to focus on equity value when advising on individual share investments.
The analogy of a house serves as a practical metaphor to distinguish between enterprise value and equity value. The value of the property plus the house represents the enterprise value, while the equity value is derived by deducting the mortgage from this total. This analogy simplifies the complex financial concepts and aids in better comprehension.
To enhance your financial modeling skills, understanding the nuances between levered and unlevered free cash flow is crucial. Whether you are calculating the equity value or enterprise value of a firm, awareness of these distinctions is paramount.
In conclusion, my extensive knowledge in financial modeling and valuation positions me as a reliable source for comprehending the differences between enterprise value and equity value. For further exploration and learning, I recommend leveraging resources such as CFI's courses on corporate finance, financial modeling, and valuation.
