Leveraged Buyouts + Website
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Leveraged Buyouts + Website
What Is Value?
B efore getting into the leveraged buyout analysis, a valuation overview is in order. The most important question before even getting into the mechanics is "What is value?" To help answer this question, we note there are two major categories of value:
1. Book value. Book value is the value of an asset or entire business entity as determined by its books, or the financials. 2. Market value. Market value is the value of an asset or entire business entity as determined by the market.
The book value can be determined by the balance sheet. The total book value of a company's property, for example, can be found under the net property, plant, and equipment (PP&E) in the assets section of the balance sheet. The book value of the shareholders' interest in the company (not including the noncontrolling interest holders) can be found under shareholders' equity.
The market value of a company can be defined by its market capitalization, or shares outstanding times share price.
Both the book value and market value represent the equity value of a business. The equity value of a business is the value of the business attributable to just equity holders - that is, the value of the business excluding debt lenders, noncontrolling interest holders, and other obligations.
Shareholders' equity, for example, is the value of the company's assets less the value of the company's liabilities. So this shareholders' equity value (making sure noncontrolling interest is not included in shareholders' equity) is the value of the business excluding lenders and other obligations - an equity value. The market value, or market capitalization, is based on the stock price, which is inherently an equity value since equity investors value a company's stock after payments to debt lenders and other obligations.
Enterprise value (also known as firm value) is defined as the value of the entire business, including debt lenders and other obligations. We will see why the importance of enterprise value is that it approaches an approximate value of the operating assets of an entity. To be more specific, "debt lenders and other obligations" can include short-term debts, long-term debts, current portion of long-term debts, capital lease obligations, preferred securities, noncontrolling interests, and other nonoperating liabilities (e.g., unallocated pension funds). So, for complete reference, enterprise value can be calculated as:
Enterprise value = Equity value + Short-term debts + Long-term debts + Current portion of long-term debts + Capital lease obligations + Preferred securities + Noncontrolling interests + Other nonoperating liabilities (e.g., unallocated pension funds) − Cash and cash equivalents
We will explain why subtracting cash and cash equivalents is significant. So, to arrive at enterprise value on a book value basis, we take the shareholders' equity (book value) and add back any potential debts and obligations less cash and cash equivalents. Similarly, if we add to market capitalization (market value) any potential debts and obligations less cash and cash equivalents, we approach the enterprise value of a company on a market value basis.
Here is a quick recap:
Valuation Category Book Value Market Value Equity Value Shareholders' Equity Market Capitalization Enterprise Value Shareholder