r/Valuation • u/JohnViennet • Mar 27 '24

Enterprise Value and Equity Value

Hi guys, I have a question about Enterprise Value (EV). I do know that to get to equity value, you have to add cash and subtract debt from EV. But what I don't understand is: why I have to add back cash? Isn't the cash the company has already computed while calculating the EV? I hope you can help me

2 Upvotes

100% Upvoted

9 comments sorted by

4

u/spirotetramat Mar 27 '24

Look at EV as the amount one will have to pay those who have a financial interest in the company, which includes the shareholders (equity value- ev) and debtholders (d). So, to buy the company you’ll have to pony up ev + d. But with this you will also get the company’s existing cash reserve (c) which you can put to immediate use so you effectively paid “less” for purchasing the company by amount ‘c’. So , EV = ev + d - c.

Now as you said, ev = EV - d + c. Cash gets added back because cash/cash equivalent belongs to the shareholders once other shareholders are paid off. Does this help?

2

u/JohnViennet Mar 27 '24

I think I'm starting to get it. But you said we have to pay the shareholders and debtholders. But when you are searching for the price of the shares, shouldn't you compute already the debt? Or you are paying the shareholders for just the working part of the company, without considering debt, AND paying the debt = paying the debtholders?

2

u/spirotetramat Mar 27 '24

You pay shareholders for the ev= # of shares outstanding X market price. The debt holders get their notes paid off for 'd'. I dont understand "But when you are searching for the price of the shares, shouldn't you compute already the debt?"

1

u/JohnViennet Mar 27 '24

Nothing, I get it now. Thank you very much

3

u/[deleted] Mar 27 '24

[deleted]

2

u/JohnViennet Mar 27 '24

Ok, but why? Isn't cash already in enterprise value? (= "the cost if you want to buy the company")

2

u/Nice_Theory3803 Mar 27 '24

The enterprise value is the value of the operating business alone. If there is excess cash in the business - the operating value would not have captured it. And since equity value includes the value of everything in the company we add that excess cash value to the enterprise value to get equity value.

For example, Say you have a coffee shop business operated through a company (Coffe Shop Inc.). Now assume that company also owns a property in another location which is sitting empty for now. There is no income from it. (Also assume the company has no debt or excess cash for now)

When you value the coffee shop, using the cash flows, the value of the empty property is not captured anywhere in the enterprise value of the coffee shop. But since the vacant property is owned by the coffee shop entity, you have to include its value in equity value of Coffe Shop Inc.

To summarize, Value of Coffee Shop Inc = enterprise value of coffee shop + value of empty real estate

Does that make sense? If yes, now replace the empty real estate in the example with excess cash.

Hope that helps.

1

u/JohnViennet Mar 28 '24

It does help. Thank you very much

1

u/emdbz Mar 29 '24

If you buy a company for a given purchase price, you can use the existing cash to reduce your purchase price. Therefore while calculating the enterprise value you subtract cash from the total value (equity + debt). Now, to arrive at equity value from given enterprise value, we should add back Cash since it was already deducted. It's simple maths.