Business banking interview questions

What is the difference between enterprise value and equity value?

Enterprise Value represents the value of the operations of a company attributable to all providers of capital.  Equity Value is one of the components of Enterprise Value and represents only the proportion of value attributable to shareholders.

How do you calculate the market value of equity?

A company’s market value of equity (MVE) equals its share price multiplied by the number of fully diluted shares outstanding.

What is the difference between basic shares and fully diluted shares?

Basic shares represent the number of common shares that are outstanding today (or as of the reporting date).  Fully diluted shares equals basic shares plus the potentially dilutive effect from any outstanding stock options, warrants, convertible preferred stock or convertible debt.  In calculating a company’s market value of equity (MVE) we always want to use diluted shares.  Implicitly the market also uses diluted shares to value a company’s stock.

How do you calculate fully diluted shares?

To calculate fully diluted shares, we need to add the basic number of shares (found on the cover of a company’s most recent 10Q or 10K) and the dilutive effect of employee stock options.  To calculate the dilutive effect of options we typically use the Treasury Stock Method.  The options information can be found in the company’s latest 10K.  Note that if the company has other potentially dilutive securities (e.g. convertible preferred stock or convertible debt) we may need to account for those as well in our fully diluted share count.

How do we use the Treasury Stock Method to calculate diluted shares?

To use the Treasury Stock Method, we first need a tally of the company’s issued stock options and weighted average exercise prices.  We get this information from the company’s most recent 10K.  If our calculation will be used for a control based valuation methodology (i.e. precedent transactions) or M&A analysis, we will use all of the options outstanding.  If our calculation is for a minority interest based valuation methodology (i.e. comparable companies) we will use only options exercisable.  Note that options exercisable are options that have vested while options outstanding takes into account both options that have vested and that have not yet vested.

Once we have this option information, we subtract the exercise price of the options from the current share price (or per share purchase price for an M&A analysis), divide by the share price (or purchase price) and multiply by the number of options outstanding.  We repeat this calculation for each subset of options reported in the 10K (usually companies will report several line items of options categorized by exercise price).  Aggregating the calculations gives us the amount of diluted shares.  If the exercise price of an option is greater than the share price (or purchase price) then the options are out-of-the-money and have no dilutive effect.

The concept of the treasury stock method is that when employees exercise options, the company has to issue the appropriate number of new shares but also receives the exercise price of the options in cash.  Implicitly, the company can “use” this cash to offset the cost of issuing new shares.  This is why the diluted effect of exercising one option is not one full share of dilution, but a fraction of a share equal to what the company does NOT receive in cash divided by the share pri