Enterprise Value vs Equity Value - Investment Banking Interview Qs
Summary
TLDRThis video script offers a clear explanation of enterprise value and equity value, using the analogy of a house to simplify complex financial concepts. It clarifies that enterprise value (EV) represents the total cost to acquire an entire asset, while equity value is what the owner retains, including cash and underlying asset value after debt is paid off. The script guides viewers through the process of calculating both values, emphasizing the importance of understanding these concepts for success in finance interviews and on the job.
Takeaways
- π The concept of enterprise value (EV) is likened to purchasing a house, where both are considered 'boxes of value'.
- πΌ Enterprise value is often referred to as 'unlevered value' because it is independent of the business's capital structure (debt and equity).
- π‘ The goal of a business, like a rented house, is to collect cash from customers, emphasizing the similarity between the two as value-generating assets.
- π° The purchase price of a business or house is synonymous with enterprise value, which represents the total amount one would pay to acquire the entire asset.
- π Understanding enterprise value helps clarify its relationship with equity value, which is a common point of confusion in finance interviews.
- π€ Equity value is what the owner of an asset possesses, which includes the underlying equity in the asset and any accumulated cash.
- π The formula to calculate equity value involves subtracting debt from the enterprise value and adding any cash on hand.
- π To convert equity value to enterprise value, one must add back the debt and remove the cash component from the equity value.
- 𧩠The capital structure, which includes debt and equity, does not affect the enterprise value, as it is a measure of the total value of the business, regardless of how it is funded.
- π The script provides a step-by-step breakdown of how to derive both enterprise value and equity value from each other, using a simple numerical example.
- π The video aims to clarify these financial concepts to improve interview performance and job effectiveness in finance roles.
Q & A
What are the two main concepts discussed in the video script?
-The two main concepts discussed in the video script are enterprise value and equity value.
Why is enterprise value often confusing for people?
-Enterprise value is often confusing for people because it is taught in a way that is not straightforward, and the term itself is specific to the finance world, which can be unfamiliar to those outside of it.
What is the basic premise of comparing a house to a business in terms of value?
-The basic premise is that both a house and a business are ways to collect cash from customers or renters, and thus they can be thought of as 'boxes of value' from an investment perspective.
What does the term 'unlevered value' refer to in the context of enterprise value?
-The term 'unlevered value' refers to the valuation of an asset that is independent of the funding structure of the business, meaning it does not consider whether the asset is funded by debt or equity.
How is the purchase price related to enterprise value?
-The purchase price is the amount paid to buy an asset, and in finance, this is often referred to as enterprise value when discussing the cost to acquire the entire business or asset.
What is the relationship between equity value and the sale of an asset?
-Equity value represents what the owner would receive after selling an asset, which is the underlying equity in the asset plus any accumulated cash, minus any debt that must be paid off.
How does the presence of cash affect the calculation of equity value?
-The presence of cash adds to the equity value because it is an asset owned by the equity holder, in addition to the underlying equity in the asset itself.
What is the formula used to calculate equity value from enterprise value?
-The formula to calculate equity value from enterprise value is: Equity Value = Enterprise Value - Debt + Cash.
How can one move from equity value to enterprise value?
-To move from equity value to enterprise value, one would add back the debt to the equity value and exclude the cash, as the cash is owned by the equity holder and not part of the enterprise value.
What is the significance of understanding the difference between enterprise value and equity value?
-Understanding the difference between enterprise value and equity value is crucial for making informed investment decisions, as it clarifies what one is actually paying for when acquiring an asset and what one owns as an investor.
How does the script suggest approaching the concepts of enterprise value and equity value in interviews?
-The script suggests that understanding these concepts thoroughly will make one more effective in interviews, as it provides clarity on how to calculate and interpret these values in various financial scenarios.
Outlines
π’ Understanding Enterprise Value and Equity Value
This paragraph introduces the concepts of enterprise value (EV) and equity value in the context of interviews, where these financial terms are often discussed. The speaker clarifies that both a house and a business can be viewed as 'boxes of value,' emphasizing the goal of a business to generate cash, similar to a rented house. The paragraph explains that enterprise value, often confusing due to its complex teaching, is essentially the total amount one would pay to acquire an entire asset, independent of its capital structure. The term 'unlevered' is introduced to describe enterprise value as being separate from the business's debt and equity composition. The speaker promises to simplify these concepts to improve interview and job performance.
π° Transitioning from Purchase Price to Equity Value
The second paragraph delves into the process of calculating equity value from the purchase price or enterprise value. It uses a hypothetical scenario where both a house and a business are purchased with a mix of debt and equity. The paragraph explains that equity value is what remains after debt is paid off from the sale of an asset. It also introduces the concept that equity value includes not just the underlying asset's value but also any cash accumulated, such as from renting out a house or business operations. The speaker illustrates this with a formula, demonstrating how to derive equity value by subtracting debt and adding cash to the sale price or enterprise value.
π Converting Equity Value to Enterprise Value
In the final paragraph, the focus shifts to the reverse process of converting equity value back to enterprise value. The speaker uses the same examples of a house and a business to demonstrate this conversion. The explanation includes removing cash from the equation and then adding back the debt to reach the enterprise value. The paragraph reinforces the idea that enterprise value represents the total value of an asset, including debt, which one would pay to acquire the entire business or property. The summary concludes by reiterating the definitions of enterprise value and equity value, emphasizing their importance in understanding business valuation and the interview process in finance-related fields.
Mindmap
Keywords
π‘Enterprise Value (EV)
π‘Equity Value
π‘Unlevered Value
π‘Capital Structure
π‘Debt
π‘Equity
π‘Purchase Price
π‘Cash
π‘Leverage
π‘Investment Banking
π‘Interview Questions
Highlights
Introduction to the concepts of enterprise value and equity value in the context of interviews.
Clarification of the often confusing concept of enterprise value.
Comparison of a house and a business as equivalent 'boxes of value'.
Explanation of purchase price and its relation to enterprise value (EV).
Definition of enterprise value as the cost to buy the entire asset.
Enterprise value referred to as 'unlevered value' due to its independence from the business's funding.
Illustration of the capital structure's role in the valuation process.
Transition from purchase price to equity value, including the concept of debt and equity.
Equity value defined as the value beyond debt, including the owner's investment.
Demonstration of calculating equity value by subtracting debt and adding cash.
Introduction of a formula to numerically work towards equity value.
Explanation of how cash affects the calculation of equity value.
Conversion of equity value to enterprise value by adding back debt.
Visual demonstration of the process from equity value to enterprise value.
Final formula for calculating enterprise value, incorporating cash and debt.
Summary of the key differences between enterprise value and equity value.
Application of these concepts to both houses and businesses.
Promise of further videos on investment banking, private equity, and hedge fund interview questions.
Transcripts
hello everyone and welcome to the next
video in our interview question review
series today we're going to review the
concepts of enterprise value and equity
value in interviews you'll often be
asked what each of these concepts mean
and how you can work from one to the
other we'll cover all that here
i should note that in particular
enterprise value is often very confusing
for folks
because it's taught in a very confusing
way we're going to aim to clarify
any confusion you have here and i
promise if you invest a little bit of
time
you'll be far more effective in your
interviews and on the job with that
let's hop in the first thing i want to
note is that a house is a business so
i'm gonna make the case here that these
two things are the same and the reason
for that is
the overarching goal of a business is to
collect
cash from customers and a house when we
rent it out is the exact same thing but
our customers are our renters they pay
us
now let's imagine that instead of
looking at this as a house and a
business as two separate things since
they are the same
we're going to think of them as just
boxes of value so i'm going to tweak the
presentation here a little bit
and we'll get rid of the house
and let's just think of these as two
different equivalent
boxes of value now let's also imagine
that we wanted to purchase the house in
particular for a hundred thousand
dollars
so to buy this house we'd have to pay
the sellers a hundred thousand dollars
out of our own pocket and that price
that we pay the sellers we would call
purchase price
if we were to buy a business it would be
the exact same thing let's imagine that
we're buying a business for a hundred
thousand dollars
but instead of calling a purchase price
we have a fancy term for this in the
finance world called
enterprise value or ev so in the end
it's the exact same thing
for both a house and a business we just
use a slightly different term
and the term enterprise value really
just means how much would we pay to buy
the entire
asset as opposed to a particular
component of the asset
the next thing to note here is that the
term enterprise value
is often referred to as an unlevered
value so levered
is leverage leverage is debt they're all
roughly equivalent terms
and the reason that that that enterprise
value is referred to as an
unlevered value is that it's independent
of the funding of the business so for
example let's imagine for both the
we're going to draw d for debt and e for
equity
let's imagine for a second that we
purchased the house with
50 of debt and 50 of equity same thing
with a business
or alternatively we purchase both with
80 of debt and 20 of equity
it really doesn't make a difference how
the how the business or the house is
funded
because we have to pay a hundred
thousand dollars no matter what so
that's why this is referred to as an
unlevered value
is because the valuation is independent
of the debt and equity and in finance
the term
the sort of the debt and equity together
referred to as the capital structure
so what we're going to do now is work
from the purchase price
down to what the owner owns which is
what we refer to as equity value
so let's again imagine that we purchased
both of these assets and we'll say
just to keep this simple we purchased
them for
50 50 debt and equity
if we wanted to look at the equity value
that we would have as the owner of
either of these assets
it would be 50 but it's not because we
invested
let's just change the color here it's
not because we invested 50
it's because if we were to go and resell
either of these assets to someone else
we would have to pay off the mortgage
before we could collect anything so
let's actually just demo this with the
house
so if we were to sell the house let's
actually get rid of the debt in equity
for a second
if we were to sell the house again we
would collect a hundred thousand dollars
but before we get anything to make this
point clear hopefully
we would have to pay our lenders fifty
thousand dollars and we get whatever's
left over which in this case
would be another fifty dollars so
equity value is really just the value
that sits beyond the debt once we've
paid off our debt
um and as we'll see in a second there's
actually a little more to this than just
the ownership in the underlying asset
and that's cash so we'll come back to
that in just a second
all right now before we move ahead i'm
going to move this down a little bit
and i'm going to draw out a formula so
we can actually work to
equity value numerically here
went a little too far
so we're going to say that equity value
equals something and we're going to work
to that something so
going back to the example we just went
through
to get to our equity value and i'm
actually going to erase the equal sign
here real quick to get to our equity
value
we would take the sale price or the
enterprise value
and we'll actually demo this with both
the business and the house side by side
so let's just do it for both and
we would have to subtract debt
uh so the debt would be 50 in each case
and again what we would have left over
is 50
of value now as i said there's a little
more to the equity value picture than
what i've showed you thus far
and that's cash let's imagine attached
to each of these items
is a bank account i'll just write bank
here
for both
and let's imagine that we've collected
ten dollars of cash
from renting out the house or ten
dollars of cash
from uh selling things to customers
as the owner of either the house or the
business we own both of these things
as well as the underlying equity in
either the house or business
so our equity value is really the
combination of the
equity in the asset as well as the cash
that we own
so that's the last piece here is we have
to add
cash to the formula so we're going to
add cash
and in this case our equity value would
be
let me just draw it out in the formula
itself will would be
a hundred thousand dollars
okay a hundred thousand dollars minus
the 50 of debt
plus the ten of equity or ten of cash
sorry
uh would give us equity value of 60.
and really what that is is just the 50
and the 10
the value in the underlying asset as
well as the cash that we have
accumulated
so we've worked equity value and now i'd
like to show you how we can work from
equity value to enterprise value so let
me get rid of some of the details here
and what we'll do is move this down and
we're going to get rid of our
numbers and we're going to draw the
formula but in a slightly different way
so we're going to start with enterprise
value
equals
so enterprise value equals is where
we're going to start
and we're going to work to enterprise
value from
our equity value
now remember that equity value includes
both
cash and the underlying equity in the in
the assets so let me actually
move this over just a little bit here
so equity value as i said is really uh
the underlying equity in the asset as
well as the cash that we own
we're going to demonstrate how you would
go from equity value to enterprise value
now
really focusing on the house and then
i'll demo it with the business so
let's start with the house here
so with the house we would start with uh
just to show this visually we'd actually
start with equity value which as we said
is 50 of underlying equity and 10
in the bank and let's imagine that we
know that this this house
has on it 50 of debt
let's make a note of that okay well
if someone said you know what is this
house worth you'd start with the sixty
dollars as the owner and you say okay
well
to begin with this ten dollars of value
that i own in cash
that's mine so if i were to ever sell
the house and the same applies to a
business
that that comes with me that doesn't go
with whoever i'm selling the house to
so i'm left with fifty dollars here the
fifty dollars
reflects all of the value of the asset
that exists after debt is paid off
so the next thing to note here is that
the only way we ever have equity value
whether
it's in a house or a business is if
there's value
beyond the debt and so acknowledging
that is important because
we have to say okay well if we have 50
of equity value
what we really need to do is add debt to
the picture because there would be no
equity value if there weren't any value
beyond the debt in this case we have 50
of debt and at that point we've now
worked
to the value of the underlying asset and
it's almost like the capital structure
the debt and equity
disappear so once we get to that point
we've really just calculated the value
of the house it's just
it's just a function of our starting
point that we had to work from the
equity value
to this but once we get to this point
there's really nothing left but the
value of the underlying house which
would be again like the list price or
the purchase price of the house
just to just to follow that and i'm
actually going to work through the
formula
this this next time with the business
it's the same exact flow
so with the business we'd start with the
60 of equity value here and i'm going to
use numbers this time around
and from that 60 we could work to the
value of the business so the first thing
we do is we would get rid of our cash
so let's let's get that out of the
picture here
and we would subtract cash
and then what we would do is we would
add
debt now in the picture it's already
done for us so it's already set up here
but you would next add debt to the
equity that you have
and again once you get to that point
it's almost as if
the entire capital structure disappears
and you get to the enterprise value
which is the price you would pay to buy
the entire business
so to punch that in our formula we would
subtract cash of 10 we would add
debt of 50 and that would get us to an
enterprise value
of 100. so to wrap things up here
we're really dealing with two concepts
enterprise value which is the value to
buy the entire asset whether it's a
business or a house
and then equity value which is what the
owner owns which is really the
underlying equity in the asset itself
as well as any excess cash that's
accumulated at a given point in time
so those are the concepts of enterprise
value and equity value uh
hopefully this makes a little bit more
sense now uh stay tuned for more of our
videos we're gonna have a lot more
coming
where we'll walk through investment
banking private equity hedge fund
interview questions and hopefully bring
some clarity to you all as you go
through your interview process
so thanks so much guys and talk soon
you
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