Banking and private equity
Valuation and DCF: the numbers you'll do on the spot
Enterprise value and equity value, free cash flow, terminal value, discounting and WACC, each with a worked example you can repeat in an interview.
Enterprise value and equity value
Enterprise value is the value of the operating business to everyone who funds it. Equity value is the value of the shares only. You move between them with the bridge.
Enterprise value = equity value + debt + preferred stock + minority interest − cash
Worked example · The bridge
Checked by codeShares trade at $20 and there are 50 million diluted shares. Debt is $300m and cash is $100m. What is the enterprise value?
Show the working
- 1.Equity value = $20 × 50m = $1,000m.
- 2.Enterprise value = $1,000m + $300m − $100m = $1,200m.
Answer$1,200m.
TipMatch the multiple to the value. EV multiples (EV/EBITDA, EV/revenue) use figures before interest, which belong to all investors. Equity multiples (P/E) use net income, which belongs to shareholders only.
Unlevered free cash flow
Unlevered FCF = EBIT × (1 − tax rate) + D&A − capex − increase in net working capital
Worked example · Free cash flow
Checked by codeEBIT is $200m, the tax rate 25%, D&A $40m, capex $60m, and net working capital rises by $10m. What is unlevered free cash flow?
Show the working
- 1.After-tax operating profit = $200m × 0.75 = $150m.
- 2.Add D&A, subtract capex and the working capital increase: $150m + $40m − $60m − $10m = $120m.
Answer$120m.
Terminal value
A large share of a DCF's value usually sits in the terminal value, so interviewers like to test it. There are two methods, and good answers cross-check one with the other.
Perpetuity growth: TV = FCF × (1 + g) ÷ (WACC − g)
g must stay below long-run economic growth.
Exit multiple: TV = final-year EBITDA × exit multiple
Worked example · Perpetuity growth, then the cross-check
Checked by codeFinal-year FCF is $120m, long-run growth 2% and WACC 8%. What is the terminal value, and what EV/EBITDA multiple does it imply if final-year EBITDA is $170m?
Show the working
- 1.TV = $120m × 1.02 ÷ (0.08 − 0.02) = $122.4m ÷ 0.06 = $2,040m.
- 2.Implied multiple = $2,040m ÷ $170m = 12.0x. Compare it with what similar companies trade at.
Answer$2,040m, which implies 12.0x EBITDA.
Discounting
Present value = cash flow ÷ (1 + r)t
Worked example · Discount the terminal value
Checked by codeThe $2,040m terminal value is reached at the end of year 5 and WACC is 8%. What is it worth today?
Show the working
- 1.1.085 ≈ 1.469.
- 2.$2,040m ÷ 1.469 ≈ $1,388m.
AnswerAbout $1,388m.
WACC
WACC = E/(D+E) × cost of equity + D/(D+E) × cost of debt × (1 − tax rate)
Cost of equity = risk-free rate + beta × equity risk premium
Worked example · Build a WACC
Checked by codeRisk-free rate 4%, beta 1.2, equity risk premium 5%. Debt is 30% of capital at a 6% pre-tax cost, and tax is 25%. What is the WACC?
Show the working
- 1.Cost of equity = 4% + 1.2 × 5% = 10%.
- 2.After-tax cost of debt = 6% × 0.75 = 4.5%.
- 3.WACC = 0.7 × 10% + 0.3 × 4.5% = 7% + 1.35% = 8.35%.
Answer8.35%.
Walk me through a DCF, in 30 seconds
- 1
Project
Forecast unlevered free cash flow for five to ten years.
- 2
Terminal value
Estimate it with a perpetuity growth rate or an exit multiple.
- 3
Discount
Bring both back to today at the WACC and add them up: that's enterprise value.
- 4
Bridge
Subtract net debt and other claims to get equity value, then divide by diluted shares for a value per share.
Common mistakes
Common mistakes
- Discounting levered free cash flow at WACC. Levered FCF goes with the cost of equity and gives equity value directly.
- A perpetuity growth rate above long-run economic growth.
- Forgetting the (1 + g) in the numerator.
- Leaving out minority interest or preferred stock in the bridge.
- Applying an equity multiple to an enterprise figure, or the other way round.
Practice this
Put the method to work on fresh questions, marked instantly.
Banking and private equity