Value can be considered on three levels:
- The value of the enterprise before taking into account its cash and debt
- The market value of invested capital (MVIC), which is equal to enterprise value plus cash
- Equity value, which is MVIC less debt.
An example illustrates the differences. Suppose an acquirer agrees to buy the stock of a company for $1 million, and the company has $2 million in debt. Will the buyer assume the debt or not? In this example, the value of the equity is $1 million, and the MVIC is $3 million.
Now suppose the company has $500,000 in cash. Will the seller transfer the cash to the buyer? The enterprise value is $2.5 million, which is the MVIC less the cash.
These distinctions can be important when considered public company multiples. A price/earnings (PE) multiple is a multiple of the company’s net income. It provides an indicator of the value of equity because net income has been reduced by interest expenses or increased by interest income. A multiple of earnings before interest expense (EBIT or EBITDA) is an indicator of MVIC.