Enterprise Value vs Equity Value
Enterprise value is the value of a firm’s core operating business, the claim shared by every provider of capital, both debt and equity. Equity value is the slice that belongs to shareholders alone, after the lenders have been paid. Because a discounted cash flow on free cash flow to the firm (FCFF) discounts cash available to all investors, it produces enterprise value first. You then walk down to equity value across the equity bridge. Keep the two separate. A multiple, a discount rate and a cash flow each belong to either the enterprise level or the equity level, never both at once.
Try it yourself
Discount free cash flow to the firm at the WACC, add a terminal value for the years beyond the explicit horizon, and you get enterprise value. Subtract net debt to reach equity value, then divide by shares for the per-share figure. Watch how much of the answer the terminal value alone carries.
In the TV-heavy case the narrow WACC − g_T gap pushes almost the whole value into the terminal value. That fragility is why analysts stress-test g_T.
Cash, not accounting profit:FCFF is cash to all capital providers after reinvestment (roughly EBIT(1 − tax) + D&A − capex − ΔNWC), not net income or EBIT. Earnings accrue revenue and expense before cash actually moves, so a profitable firm can still have weak FCFF.
Reflect: when the terminal value is 80%+ of EV, the valuation rests less on the five years you forecast carefully and more on one perpetual-growth guess. Does a longer explicit horizon genuinely reduce that reliance, or does it just move the same uncertainty further out?
Why it matters
Picture the business as a house and the mortgage as the debt on it. The house has a value of its own no matter who financed it, and that is enterprise value. What the owner actually keeps is the house value minus the mortgage, and that is equity value. An FCFF model values the whole house because operating cash is generated before any lender or owner is paid. Confusing the two is the most common valuation error students make, because a healthy enterprise value can still leave thin equity once heavy debt is subtracted.
Formulas
Worked examples
An FCFF model puts a firm’s enterprise value at US$100m. The firm carries US$30m of debt and holds US$5m of cash, with no minorities or associates and 10m shares. What is the equity value per share?
Net debt is US$30m of debt minus US$5m of cash, which is US$25m. Equity value is enterprise value of US$100m minus net debt of US$25m, which is US$75m. Divided by 10m shares, that is US$7.50 per share. Notice the enterprise value alone, US$100m, tells a shareholder nothing until the lenders are subtracted. The same US$100m enterprise on US$60m of net debt would leave only US$40m of equity, or US$4.00 a share.
Common mistakes
- ✗Enterprise value and equity value are interchangeable. They sit one bridge apart. Enterprise value belongs to all capital providers, equity value belongs to shareholders after debt.
- ✗You discount FCFF to get equity value directly. FCFF is cash to all investors, so discounting it yields enterprise value. Only the bridge then converts it to equity.
- ✗A higher enterprise value always means richer shareholders. Heavy net debt can swallow most of the enterprise value, leaving little for equity.
- ✗Market capitalisation is the same as enterprise value. Market cap is equity value. Enterprise value adds net debt and other claims on top of it.
Revision bullets
- •Enterprise value is the value of the operating business to all capital providers
- •Equity value is the shareholders’ residual claim after debt
- •An FCFF discounted cash flow produces enterprise value first
- •Cross from enterprise to equity through the equity bridge
- •Market capitalisation is equity value, not enterprise value
- •Match each cash flow, rate and multiple to its own level
Quick check
Discounting free cash flow to the firm at the WACC produces
A firm has an enterprise value of US$200m and net debt of US$80m, with no minorities or associates. Its equity value is
Connected topics
Sources
- Titman & Martin, Ch. 9Titman, S., & Martin, J. D. Valuation: The Art and Science of Corporate Investment Decisions. Pearson.Develops enterprise valuation by discounting firm free cash flow and separating it from the equity claim.
- Koller, Goedhart & WesselsKoller, T., Goedhart, M., & Wessels, D. Valuation: Measuring and Managing the Value of Companies. McKinsey & Company / Wiley.Standard reference on the enterprise-to-equity distinction and consistent treatment of capital claims.