DCF DCF Equity Value and Enterprise Value 2 — Questions and Answers
Question 1: What is included in 'net debt' when bridging from EV to equity value in a DCF?
- Total debt plus preferred stock and minority interest, minus cash and equivalents (Correct answer)
- Only long-term debt minus cash
- Short-term debt minus accounts payable
- Total liabilities minus total assets
Correct answer: Total debt plus preferred stock and minority interest, minus cash and equivalents
A complete net debt bridge includes total debt, preferred stock, and minority interest as debt-like items, minus cash and cash equivalents.
Question 2: If a DCF model yields an equity value of $800M and the company has 40M diluted shares outstanding, what is the implied share price?
- $20.00 (Correct answer)
- $32.00
- $40.00
- $8.00
Correct answer: $20.00
Implied share price = equity value / diluted shares = $800M / 40M = $20.00 per share.
Question 3: Why should diluted shares (not basic shares) be used when calculating implied share price in a DCF?
- Diluted shares include options and warrants that will create additional shares if exercised, diluting existing shareholders (Correct answer)
- Diluted shares are always lower than basic shares
- Basic shares exclude treasury shares which must be counted
- Diluted shares reflect only insider ownership
Correct answer: Diluted shares include options and warrants that will create additional shares if exercised, diluting existing shareholders
Diluted shares include all potential shares from options, warrants, and convertibles, providing a more conservative and accurate per-share valuation.
Question 4: A company with EV of $1B has $200M in cash, $300M in debt, and $50M in preferred stock. What is the equity value?
- $850M (Correct answer)
- $950M
- $750M
- $1.05B
Correct answer: $850M
Equity value = EV – debt – preferred stock + cash = $1,000M – $300M – $50M + $200M = $850M.
Question 5: What does it mean if a company's DCF-implied equity value is negative?
- The company's net debt exceeds its enterprise value, meaning it is technically insolvent on a DCF basis (Correct answer)
- The DCF model was built incorrectly and must be rerun
- The company's free cash flows are negative temporarily
- The terminal value is too low due to excessive discounting
Correct answer: The company's net debt exceeds its enterprise value, meaning it is technically insolvent on a DCF basis
A negative equity value means the present value of the business is less than the net debt burden, implying the equity is worth zero and the company is over-leveraged.
Question 6: In a leveraged buyout (LBO) DCF context, why does higher leverage typically increase equity value even if EV stays the same?
- It does not; higher leverage reduces equity value because net debt increases (Correct answer)
- Leverage adds a tax shield that raises EV
- Equity sponsors always add value through operational improvements
- Interest deductions reduce WACC, raising EV and equity simultaneously
Correct answer: It does not; higher leverage reduces equity value because net debt increases
Higher leverage means more net debt, which reduces equity value (EV minus net debt), not increases it — equity sponsors earn returns through EV growth, not leverage math alone.
DCF DCF Equity Value and Enterprise Value 2
What is included in 'net debt' when bridging from EV to equity value in a DCF?