Equity Value to Enterprise Value Bridge
What is the Equity Value to Enterprise Value Bridge?
The Equity Value to Enterprise Value Bridge illustrates the relationship between a company’s equity value and enterprise value (TEV).
Specifically, the bridge is created to reflect the variance between a company’s equity and enterprise value (and which factors contribute to the net difference).
How to Calculate Enterprise Value from Equity Value
The two primary methods to measure a company’s valuation are 1) enterprise value and 2) equity value.
- Enterprise Value (TEV) → The value of a company’s operations to all stakeholders, including common shareholders, preferred equity holders, and providers of debt financing.
- Equity Value → The total value of a company’s common shares outstanding to its equity holders. Often used interchangeably with the term “market capitalization”, the equity value measures the value of a company’s total common equity as of the latest market close and on a diluted basis.
The difference between enterprise value and equity value is contingent on the perspective of the practitioner performing the analysis, i.e. the company’s shares are worth different amounts to each investor group type.
The equity value, often referred to as the market capitalization (or “market cap” for short), represents the total value of a company’s total common shares outstanding.
To calculate the equity value, the company’s current price per share is multiplied by its total common shares outstanding, which must be calculated on a fully-diluted basis, meaning that potentially dilutive securities such as options, warrants, convertible debt, etc. should be taken into consideration.
Equity Value = Latest Closing Share Price × Total Diluted Shares Outstanding
In contrast, enterprise value represents the total value of a company’s core operations (i.e. the net operating assets) which also includes the value of other forms of investor capital such as financing from debt investors.
On the other hand, to calculate a company’s enterprise value, the starting point is the company’s equity value.
From there, the company’s net debt (i.e. total debt less cash), preferred stock, and non-controlling interest (i.e. minority interest) are added to the equity value.
The equity value represents the entire company’s value to only one subgroup of capital providers, i.e. the common shareholders, so we’re adding back the other non-equity claims since enterprise value is an all-inclusive metric.
Enterprise Value = Equity Value + Net Debt + Preferred Stock + Minority Interest
However, a critical concept to understand is that the addition of new debt does NOT increase a company’s enterprise value.
The reason is newly raised capital via debt financing flows directly into the cash balance of the company, so the two offset each other, since net debt is the difference between total debt and cash.
Net Debt = Total Debt – Cash and Cash Equivalents
What’s the Difference Between Equity Value and Enterprise Value?
To reiterate the key points mentioned in the prior section – enterprise value is the value of a company’s operations to all capital providers – e.g. debt lenders, common shareholders, preferred stockholders – which all hold claims on the company.
Unlike the enterprise value, the equity value represents the remaining value that belongs to solely common shareholders.
The enterprise value metric is capital structure neutral and indifferent to discretionary financing decisions, making it well-suited for purposes of relative valuation and comparisons among different companies.
For that reason, enterprise value is widely used in valuation multiples, whereas equity value multiples are used to a lesser extent.
The limitation of equity value multiples is that they are directly impacted by financing decisions, i.e. can be distorted by capital structure differences rather than operating performance.
Equity Value to Enterprise Value Formula
The following formula is used to calculate equity value from enterprise value.
Equity Value = Enterprise Value — Net Debt — Preferred Stock — Minority Interest
Starting from enterprise value, net debt, preferred stock, and minority interest is subtracted to arrive at equity value.
Equity Value to Enterprise Value Bridge Calculator
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Equity Value to Enterprise Value Bridge Calculation Example
Suppose a public company’s shares are currently trading at $20.00 per share in the open markets.
On a weighted average and diluted basis, the total number of common shares outstanding is 1 billion.
- Current Share Price = $20.00
- Total Common Shares Outstanding = 1 billion
Provided those two inputs, we can calculate the total equity value as $20 billion.
- Equity Value = $20.00 × 1 billion = $20 billion.
Starting from equity value, we’ll now calculate enterprise value.
The three adjustments consist of:
- Cash and Cash Equivalents = $1 billion
- Total Debt = $5 billion
- Preferred Stock = $4 billion
The enterprise value of our hypothetical company amounts to $28 billion, which represents a net differential of $8 billion from the equity value.
- Enterprise Value = $20 billion – $1 billion + 5 billion + 4 billion = $28 billion
An illustration showing our equity value to enterprise value bridge from this example can be seen below.
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Investment in Associates
Investment in associate refers to the investment in an entity in which the investor has significant influence but does not have full control like a parent and a subsidiary relationship. Usually, the investor has a significant impact when it has 20% to 50% of shares of another entity.
Table of contents
- Investment in Associates Definition
- Accounting for Investment in Associates
- Example of Investment in Associates
- Basic Example
- Practical Example – Nestle’s Investment in Associates
- Practical Example – Siemens AG
- Investment in the associate is an entity where the investor has a significant effect but does not have complete regulation like a parent and a subsidiary relationship. Generally, the investor has a significant impact when it has another entity’s 20% to 50% of shares.
- Accounting for investment in associates is conducted using the equity method. In the equity method, a 100% consolidation is not used. Instead, the proportion of shares owned by the investor is shown as an investment in accounting.
- Investment in associates is typical for companies to utilize the investment to take a lesser stake in another company.
Accounting for Investment in Associates
Accounting for investment in associates is done using the equity method. In the equity method, there is not a 100% consolidation used. Instead, the proportion of shares owned by the investor will be shown as an investment in accounting.
When an investor takes more shares in associates than in the investor’s balance sheet, it is recorded as an “increase in associates,” and the same amount reduces cash. The dividend from the associate is shown as an increase in money for the investor. To record the proportion of the net income of an associate, the investment revenue of the investor gets credit, and investment in the associate account gets debited.
Example of Investment in Associates
Below are some of the basic to advanced examples of investment in associates.
Basic Example
Suppose ABC Corp. has purchased 30% shares of XYZ Co. That means ABC Corp. has significant influence over XYZ Co. Therefore, XYZ Co. can be treated as an associate of ABC Corp. The value of 30% shares is $500,000. So, while making a purchase, below will be an accounting transaction for ABC Corp.
After 6 months, XYZ Co. declares $10,000 dividends to its shareholders. That means ABC Corp. will receive 30% of dividends or $3,000. Below will be accounting entries for the same: –
XYZ Co. also declares a net income of $50,000. Accordingly, ABC Corp. will debit 30% of $50,000 in its “Investment in Associates” account while crediting the same amount as “Investment Revenue” in its income statement.
The ending balance of ABC Corp. “Investments in Associates” account increased to $512,000.
Practical Example – Nestle’s Investment in Associates
Nestle is a Swiss multinational company headquartered in Switzerland. Nestle, the largest food company, globally had around CHF 91.43 billion in revenue in 2018. Below is the income statement of Nestle as per the 2018 annual report.
We can see that income from associates has increased from CHF 824 million to CHF 916 million.
Also, as per the balance, their Investment in Associates account has gone down from CHF 11.6 billion to CHF 10.8 billion.
Below is the more detailed information on associates for Nestle: –
In L’Oreal, Nestle has 23% shares after eliminating its treasury shares. Nestle holds another number of associates also, but that is not material. Major factors in investment in associates are share of results with CHF 919 million.
Practical Example – Siemens AG
Siemens AG is a German multinational company headquartered in Berlin and Munich. Siemens AG mainly operates in energy, healthcare, and infrastructure. Their revenue is around €83 bn as per the 2018 annual report. Below is the balance sheet snippet for Siemens AG, which shows its investment in associates, which is shown under “Investment in Accounted for using the equity method.”
As we can see, their associates’ investment has changed from €3 billion to €2.7 billion.
We can see below their definition of associates also.
As we have mentioned above, they treat the investment as associates in which they have 20% to 50% shares, and they are using the equity method to account that investment is recognized at cost.
Advantages
- With these investments, investors show an accurate and reliable income balance. In addition, it shows the percentage of earnings from its investment.
- Since the investor shows the only percent of income or investment in an associate, it is easy to reconcile the accounts.
Disadvantages
- It is a bit complex to do the accounting for this method. A lot of time is required to gather and analyze, evaluate the figures, and get the correct information.
- The investor cannot show dividends from associates as revenue. It can only be treated as a “reduction to investment” amount and not as a dividend income.
Important Points to Note about Change in Investment in Associates
- A company is treated as an associate when the share in investee is between 20% and 50%.
- The equity method is used to do the accounting.
- Investment is treated as an asset, and only the percentage of shares bought is treated as an investment.
- Dividends are treated as a change in investment, not the dividend revenue.
Conclusion
Investment in associates is common for companies to use their investment to take a lesser stake in another company. The equity method is useful for the accounting process for these investments. Though companies can show the net income of the associate company as part of their revenue, dividend income won’t be part of it, and it would be a reduction in the “investment in associate” asset.
Frequently Asked Questions (FAQs)
How do you test for impairment of investment in associates?
Suppose the investment carrying amount in an associate or joint venture increases its recoverable amount. As a result, an impairment loss is identified. However, the loss is allocated to the investment as a whole and not to the underlying assets of the investee that make up the carrying amount of the investment.
Is investment in associates a current asset?
Investments in associates using the equity method are classified as non-current assets. As a result, the investor’s profit or loss shares of associates and the carrying amount of those investments are separately revealed.
Why subtract investment in associates from enterprise value?
The minority interest value is added because it shows the claim on assets consolidated into the firm. The value of associate companies is deducted as it shows the claim on assets consolidated into other firms.
How do you account for investment in associates?
Investments in associates using the equity method must be classified as long-term investments and revealed distinct in the consolidated balance sheet. Accordingly, the investor’s share of the profits or losses of such assets should be disclosed separately in the consolidated statement of profit and loss.
Recommended Articles
This article has been a guide to investment in associates and its definition. Here, we discuss how accounting for investments in associates is done along with examples, advantages, and disadvantages. You can learn more about financing from the following articles: –
- Multinational Company
- Mergers vs. Acquisitions
- What is Mergers and Acquisitions?
- Synergies in M&A
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