1. Enterprise Value vs Equity Value
Before we get into the details of the various valuation methodologies,
we must first understand what enterprise value is and what equity value
is. We're going to break down the enterprise value and equity value of
a business with an illustration for you. The value of the entire company
is the sum of the market value of its assets,
those assets are used to generate cash flows,
that's essentially what is known as the enterprise value,
the value of the entire firm, the value of the entire enterprise.
But a company has a capital structure, those assets were purchased or financed
with a combination of debt and equity. So on the other side of
this diagram, we can see how capital structure impacts what the equity shareholders
own. Let's suppose the assets were financed 25% with debt and 75%
with equity capital. What this means is, after deducting what the debt investors
have helped to finance, you have what's left over for the equity investors.
So what's left to the shareholders is the equity value of the business,
but the market value of all of the assets of the entire company
is the enterprise value. Let's take another look at this, using a house
as an example.
2. Let's practice!