Enterprise Value vs Equity Value - Investment Banking Interview Qs

Summary

This 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

• 🏠 The concept of enterprise value (EV) is likened to purchasing a house, where both are considered 'boxes of value'.
• 💼 Enterprise value is often referred to as 'unlevered value' because it is independent of the business's capital structure (debt and equity).
• 💡 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.
• 💰 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.
• 📉 Understanding enterprise value helps clarify its relationship with equity value, which is a common point of confusion in finance interviews.
• 🤔 Equity value is what the owner of an asset possesses, which includes the underlying equity in the asset and any accumulated cash.
• 🔄 The formula to calculate equity value involves subtracting debt from the enterprise value and adding any cash on hand.
• 🛑 To convert equity value to enterprise value, one must add back the debt and remove the cash component from the equity value.
• 🧩 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.
• 📈 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.
• 🚀 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

00:00

🏢 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.

05:01

💰 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.

10:02

🔄 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.

Keywords

💡Enterprise Value (EV)

Enterprise Value (EV) is a measure of a company's total value, often used in finance to determine how much it would cost to buy the entire company. It includes the company's equity, debt, cash, and other claims against the company. In the video, EV is likened to the purchase price of a house or business, illustrating that it represents the cost to acquire the entire asset, regardless of its capital structure.

💡Equity Value

Equity Value refers to the value of an asset after all liabilities (such as debt) have been subtracted. It represents the ownership interest in the asset. In the video, equity value is demonstrated through the example of selling a house, where after paying off the mortgage (debt), the remaining amount is the equity value owned by the seller.

💡Unlevered Value

Unlevered Value is a term used to describe the value of an asset without considering the impact of any debt or financial leverage. In the context of the video, enterprise value is often referred to as unlevered because it is independent of the company's capital structure, meaning it does not matter how the asset is financed; the value remains the same.

💡Capital Structure

Capital Structure refers to the composition of a company's or an asset's liabilities and equity, the mix of debt and equity used to finance its operations. The video explains that the capital structure does not affect the enterprise value, as it is the total value of the company regardless of how it is financed.

💡Debt

Debt is an amount of money borrowed by an entity that must be repaid, with interest, at a later date. In the video, debt is used in the context of purchasing a house or business, where it is part of the capital structure and affects the equity value but not the enterprise value.

💡Equity

Equity, in a financial context, represents the ownership interest in an asset after all liabilities have been paid off. The video uses the term to describe the portion of the asset that is owned by the individual or company, as opposed to what is owed to creditors.

💡Purchase Price

Purchase Price is the amount paid for an asset, such as a house or business. The video script uses the term to illustrate the initial cost of acquiring an asset, which is analogous to the enterprise value when referring to a business.

💡Cash

Cash, in the context of the video, refers to liquid assets or money that can be readily used to pay off debts or for other transactions. It is part of the equity value calculation, as it represents the excess funds that the owner has beyond the underlying equity in the asset.

💡Leverage

Leverage, in finance, is the use of borrowed money to increase the potential return of an investment. The video script explains that enterprise value is referred to as unlevered because it does not take into account the leverage used to finance the business.

💡Investment Banking

Investment Banking is a division of banking that assists individuals, corporations, and governments in raising capital by underwriting or acting as the client's agent in the issuance of securities. The video mentions investment banking as part of the broader finance industry where concepts like enterprise and equity value are crucial for evaluating potential investments.

💡Interview Questions

The video script is part of an interview question review series, where interview questions are discussed and explained to help job candidates prepare for their interviews in finance-related fields. Understanding these key concepts is essential for success in finance interviews, as they are often part of the questions asked to assess a candidate's knowledge and analytical skills.

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