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Accounting Allah shmoop enterprise value to eave it Doc Okay

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First things first Enterprise value the value of the whole

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enchilada The lettuce the cheese the corn flour tortilla The

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you know mystery meat The enterprise value of a given

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business is the total cost to replace it So if

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you had a home you just bought for two hundred

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thousand dollars down with a five hundred thousand our mortgage

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the enterprise value of that home would be seven hundred

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grand And parenthetically it's equity value would be two hundred

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grand and you'd have two hundred grand in equity in

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it and five hundred grand in debt on it Businesses

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air valued And I'm kind of in a similar way

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A company with say a hundred million dollars in even

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or cash flow or cash profits might trade it and

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say twelve times that even don number for now Don't

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worry about why it trades a twelve twenty five at

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twelve times that hundred million dollars in cash flow That

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company is worth one point two billion dollars Why Because

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Wall Street says so But the market capitalization of the

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company might be we'll say only seven hundred million Why

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Well because it has six hundred million dollars in debt

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and one hundred million dollars in cash or net debt

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of five hundred million box so that five hundred million

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get subtracted from the one point two billion total to

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get the equity value or set another way The enterprise

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value of that business is one point seven billion because

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you'd add that five hundred million dollars to the enterprise

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notionally worth twelve times that hundred million bucks in cash

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flow to try and replace it Lots of numbers and

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ratios were thrown at you here So hang glider loose

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or however you want Okay so even even does a

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common evaluation metric or ratio in companies that a have

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a lot of debt be are depreciating A lot of

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capital expenditures and well see often don't have meaningful gap

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earnings So another method has to be worked out to

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evaluate their self worth other than ours The Friday in

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therapy will help in the numbers Let's redo our definition

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here of enterprise value from another angle there or even

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the same angle there but with different lenses All right

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there we go Let's start with a new home The

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rich version of you just bought it for a million

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dollars putting two hundred grand down and taking out a

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mortgage for a hundred thousand bucks The equity or equity

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capitalization Our equity value you have in your home at

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this point is what now Yes two hundred thousand dollars

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and the home's enterprise values a million bucks right We've

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just said that because it would take a million bucks

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toe fully replace that home Its enterprise value is a

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million dollars Yes we're hammering this home Okay now back

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to a more detailed company story Let's say human catapulting

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has even Dov Forty million and one hundred sixty million

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of debt Its growth rate in the industry trend suggested

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it should trade about and ten times Even so ten

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X EBITDA would give us four hundred million dollars of

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gross value for the company But there's a hundred sixty

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million dollars of debt which has to be subtracted from

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the gross value to get the equities value So we

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subtract hundred sixty million from the four hundred million dollars

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to get two hundred forty million dollars of equity value

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Like if the stock was trading publicly and there were

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say ten million shares out it would be trading probably

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at about twenty four bucks a share right Because the

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stock price shows you what the equity value is The

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Wall Street paying for it And we'd say that this

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firm with one hundred sixty million dollars of debt is

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lev ird for toe one debt Teo even dog that

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is one hundred sixty million of debt TTO forty million

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of even doc We don't ask ourselves Well how does

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this company compare to human slingshots ink and to the

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humoring ink as weapons of Miss Destruction Right Well slingshots

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traded a lower multiple because while misfires air costly but

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Human Rang trades at a premium of twelve times a

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bit DA because of the nature of its physics in

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the form of reusable humans when the shot is a

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mist well this would be the comparable company multiple or

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come Paco and in this case human catapults trade and

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as might be expected at the midpoint of the range

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of comparables aren't the last Metro is discounted cash flow

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analysis which is the heavy valuation machinery that the professionals

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generally used along with a weighted average cost of capital

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In putting mathey clarity around their investment dollars Remember the

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mantra A dollar today is worth more than a dollar

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tomorrow This is the heart and soul of discounted cash

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flow analysis Right So you're going to discount cash flows

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into the future for risk and time But let's take

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a deeper look A company will produce Net after everything

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cash of one hundred dollars in your one two hundred

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dollars in year two two fifty and three five hundred

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for and eight hundred in Year five When it gets

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sold on that eight hundred includes it's selling price so

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this would be called shockingly a five year discounted cash

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flow analysis Well your next step here is figure out

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the discount rates The risk free rate is usually whatever

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US government bond paper trades for In the analogous time

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period that is you'd find a ten year T bill

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that is halfway through its life span and figure out

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what the rate is that it's paying If you went

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to buy it right now so I'll say it's three

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percent that's the five year risk free rate The risk

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premium is the extra rate of interest You're going to

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account for the likelihood that instead of producing in millions

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on hundred two hundred to fifteen above above the company

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produces on LY one hundred one hundred one hundred hundred

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fifty so the company might do terribly relative to expectations

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But it also might do a ton better than you

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know your gases or projections The projection should generally be

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in the fifty fifty over under his own III the

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most likely case like you know when you have an

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NFL game and there's a fifty fifty over under for

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how many points are scored for both sides you know

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stuff like that So let's say the premium on this

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set of cash flows is eight percent to produce a

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total of eleven percent That is there's eight percent in

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risk on top of the risk free rate that attack

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on right so total discount rate will be eleven percent

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You then just set up the equation such that the

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first five years show cash produced And then at the

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end of those five years company is sold or goes

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public or gets liquid or whatever But you sell all

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your shares or all your assets or ownership and you

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know you get your terminal value there Your end value

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So let's say the company sells for a billion dollars

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at the end when the tricky part in this SAT

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lies in the power it aeration of the equation And

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it would look something like this Yeah you don't need

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to do the math here All you have to do

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is think Yes we ask a lot Note that the

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denominator of one point one one is iterated a ton

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more in the out years versus hear one and one

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point one one two the fifth powers about one point

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seven So yeah interesting In your five you're dividing those

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huge numbers by a pretty big number The notional eight

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hundred million dollars in profits on a discounted basis is

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only around four hundred seventy million Only stuffs what it's

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worth today Almost half that is its present value is

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just a bit more than half its terminal value The

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key notion here is to separate balance sheet shenanigans and

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our assets from the future earnings potential of the company

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itself It is this separation that usually motivates an enterprise

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value to even top perspective or valuation of a company

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because in doing so the balance sheet is then separated

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into the naughty chair words It's alone where it can

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cloud the picture of the actual earnings potential of the

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company itself and more pedantic Lee Company with a billion

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dollars of net cash on its balance sheet should in

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fact have a different lens looking at it like a

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green one because it has so much excess cash you

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know that it would when compared with a company with

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three billion dollars of net debt So bottom line the

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balance sheet matters a lot You have to adjust your

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ratios to reflect company values because of it and you

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know balance sheet matters And when it gets so does 00:07:40.277 --> [endTime] the thickness of the wall That's gotta hurt Hey

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