Equity value and Enterprise value are both used in the valuation or sale of a business, but each provides a slightly different view of the company.
While equity value is mostly used by shareholders and owners as it provides information about the shareholder’s part in the company’s value without including any debt obligations.
Enterprise value calculates the general value of the business including debt and equity. In this article, we will briefly discuss equity value and enterprise value.
EQUITY VALUE
Equity value is also known as market capitalization. The value available to the owners or shareholders of the company is known as equity value. Hence, one could present the following obvious definition of equity value as the total value of the company that belongs to equity investors.
However, equity value is more familiarly referred to as the market value of equity or market capitalization. It is a product resulting from multiplying a company’s share price by the outstanding number of its shares.
Equity value can also be derived by starting with the Enterprise Value of a firm, as shown below:
Equity value = Enterprise value – debt + cash or cash equivalent
OR
Equity value = current share price × number of share outstanding
To calculate equity value from enterprise value, simply subtract the value of debt and add cash or cash equivalent. Equity value has to do with what is available to equity shareholders.
ENTERPRISE VALUE (EV)
Enterprise value is probably one of the most basic and core concepts in corporate valuation. It forms the basis for a number of Merger & Acquisition deals.
EV is said to be the actual cost of purchasing a company or the theoretical price of a company before a takeover is considered. It is, in fact, the minimum value that an entity would pay to buy a company.
There are two types of formula of enterprise value:
Simple formula:
EV = market capitalization + market value of debt – cash or cash equivalent
Extended formula:
EV = common share + preferred share + market value of debt + minority interest – cash or cash equivalent
KEY DIFFERENCE BETWEEN EQUITY VALUE OR ENTERPRICE VALUE
USE OF EQUITY VALUE AND ENTERPRISE VALUE IN VALUATION
If you compare enterprise value with equity value, you will find that enterprise value is utilized much more than equity value. This is because enterprise value allows analysts to remove the capital structure from the valuation process. By eliminating the capital structure from its matrix, enterprise value makes companies more comparable with each other, unlike equity value. This is why it is relied upon more in valuation techniques.
For example, in investment banking, enterprise value or the entire business is seen more frequently in advisory positions in M&A.
While analysts use enterprise value more than equity value, the latter is still an important technique used in equity research by investors. Investors, wanting to purchase individual shares of a company rather than the whole business, utilize equity value to assess the current company value and calculate its future value, considering potential share price appreciation.
Equity value is preferred in equity research because analysts advise investors on purchasing individual shares instead of the overall business.
Example of equity value and enterprise value
Suppose you wish to buy a house for Rs 60 lakh but do not have the full amount. You take a loan of Rs 35 lakh and provide Rs 25 lakh as advance payment for the house.
The total value of the house, Rs 60 lakhs, is the enterprise value, while your down payment of Rs 25 lakhs represents the equity value. The enterprise value is the sum of contributions from both parties – the equity holder (who made the down payment) and the debt holder (the bank). When both values are combined, the enterprise value is obtained.
CONCLUSION
The enterprise value indicates the amount a company would receive by selling the entire company in the market. It is crucial for companies involved in Mergers and Acquisitions to ensure they do not overpay for the acquired company.
Equity value, on the other hand, is the portion of enterprise value related to the equity side of the company and reveals the value the company could generate if one were to purchase its shares. Understanding the difference between enterprise value and equity value allows for better decision-making in valuing companies.
In short, Equity value and enterprise value are used for different purposes in order to study organizations for investment purposes. Equity value/market cap can be used as a profile of the organization. On the other hand, Enterprise value is used to calculate the market value of an organization.