Bridge from Enterprise Value to Equity Value

The file below demonstrates how to evaluate whether various elements should be included or not included in the bridge between equity value and enterprise value. It deals with things like the value of derivatives and deferred taxes associated with the derivatives. The proofs develop both true cash flow and the accounting for cash flow.

In a similar manner as a high project IRR can be a danger sign of pending over-capacity in project finance, a high ROIC may suggest that companies will try and enter the industry and increase supply. While evaluating ROIC is important in corporate analysis, the statistic must be adjusted for goodwill write-offs, restructuring charges, impairments and other accounting items. Risk assessment in corporate finance involves judging how EBITDA can change due to factors such as technical obsolescence, changes in consumer tastes, changes in cost structure, and a host of factors including industry demand and supply that can create oversupply in an industry. Rigorous analysis of potential changes in EBITDA are hardly ever dealt with in finance texts. Assessments of business risk that is driven by volatility in EBITDA are treated using opaque and confusing jargon by credit rating agencies such as Standard and Poor’s.

Using multiples such as the P/E ratio and the EV/EBITDA ratio in valuation can be result in biases without understanding how the multiples are affected by assumptions with respect to long-term growth and long-term earnings potential. The EV/EBITDA ratio is strongly affected by the lifetime of assets used in the business and the necessity to replace capital expenditures.

This file is a corporate model for a chicken producer with returns that are affected by changing politics. It demonstrates how you can develop stable ratios and normlised cash flow. It includes stable ratio of capital expenditures and other issues as well as stable ROIC.

Advanced Valuation Lesson Set 5: Calculation of the Bridge Between Enterprise Value and Equity Value (otherwise known as Net Debt) including Fair Valuation of Derivatives, Operating Reserves, Deferred Tax Allocations, and Adjustments to WACC


The first file demonstrates that when the target capital structure does not equal the current capital structure, discounting free cash flows at the WACC (which does not change in theory when the capital structure changes) gives the same answer as computing a new cost of equity with changing capital structure.