Is Equity Value Important To A Firm? (Resourceful)

Part – 16

How to Calculate the Equity Value for a Firm

In our last tutorial, we have learnt about some adjustments for valuation and enterprise value. In this article we will learn about equity value of Firm post adjustment and the sensitivity analysis.

DCF values represent the total, or enterprise value of the business, including both debt and equity. A DCF can also be used to derive an equity value. To calculate the value of the company’s equity alone assuming its current capital structure, subtract the company’s existing net debt from the DCF’s enterprise value. Once equity value is calculated, it is useful to divide it by the number of shares outstanding in order to reach equity per share. This amount can then be compared to a market price or price derived through other valuation methodologies.

Once a base case is established, a DCF analysis should always be tested under various sensitivity scenarios. Testing involves examining the incremental effect of various changes in assumptions (lower revenue growth, higher capital requirements, etc) on the DCF value and various pro forma statistics. Sensitivity testing can be done using either static (single-variable) or dynamic (multivariable) approach. Static testing can be used to increase your understanding of the financial and operating structure of the business (and check your intuition). Obviously, the sensitivity of the DCF value and pro forma statistics varies for different assumptions and different businesses. For instance, the value of a company with high operating leverage (heavy fixed costs) is very sensitive to revenue increases or shortfalls.

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Dynamic testing can be used in the same manner as static testing; however, it can also be used to develop cases that reflect certain macro views about the company, the industry and the economy. For instance, in a scenario reflecting the possibility of the economy slipping into a recession, revenue growth could be slowed (both price and volume), but labour expense, capital expenditures and working capital, may be able to be reduced below previous levels. Thought and common sense should be employed in developing reasonable and useful sensitivity cases. The results of these cases should be attached to your DCF analysis in a clear, concise format.

The data table function is especially useful for conducting Share Price sensitivity analysis

What Next

In this article we have understood sensitivity Analysis, we will see DCF Excel Summary in next article. Till then, Happy Learning!

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Here are some articles that will help you to get more detail about the equity value important to a firm so just go through the link.

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