The bridge: from equity value to enterprise value
“Why do you add debt and subtract cash to get to enterprise value?”
Anyone can recite the formula. The interviewer is checking whether you understand the logic well enough to handle items you've never memorized, like pensions or equity investments.
EV must describe the same investors as the metric it's paired with. Add claims whose earnings are in EBITDA; subtract assets whose earnings aren't.
Each piece, and why
Debt is a claim on the operations from lenders, so it's added. Preferred stock sits ahead of common shareholders, much like debt, so it's added. Cash isn't part of the operations: it doesn't produce EBITDA, so it's subtracted.
Noncontrolling interest confuses people most. If a company owns 70% of a subsidiary, accounting rules make it consolidate 100% of that subsidiary's revenue and EBITDA. To compare apples to apples, EV must include 100% of the subsidiary's value, so we add the 30% owned by outsiders.
- 1Equity value = 25 × 40 = $1,000.
- 2Add debt, preferred and NCI: 1,000 + 400 + 60 + 40 = $1,500.
- 3Subtract cash: 1,500 − 100 = $1,400.
The rule for everything else
Ask one question about any new item: is its income, or its cost, already reflected in EBITDA? Equity stakes in companies you don't consolidate earn income below EBITDA, so their value comes out of EV, mirroring NCI. Unfunded pensions are an obligation to former employees, much like debt, so many bankers add them. Leases depend on whether the lease cost sits above or below EBITDA in your numbers.
If you're ever unsure in an interview, say the rule out loud: “I'd include it if the metric in the denominator includes its earnings.” That earns more credit than guessing.
Say it like this
We add debt because lenders also have a claim on the company's operations, and enterprise value measures the business for all capital providers. Preferred stock and noncontrolling interests are added for the same reason; noncontrolling interest specifically because we consolidate 100% of a majority-owned subsidiary's financials. We subtract cash because it's a non-operating asset that doesn't contribute to EBITDA, so it isn't part of the core business's value.
Traps to avoid
- ✕Saying cash is subtracted “because the buyer gets it back” with no deeper reason. Lead with “non-operating”.
- ✕Adding equity investments, like NCI. They're the mirror image: subtract them.
- ✕Adding working capital items like payables. They're operating, already in the business's cash flows.
What they'll ask next
›Should you use book or market value of debt?
Market value in theory; book value is the usual approximation unless the debt trades far from par, as in distress.
›How do you treat operating leases?
Be consistent: if your EBITDA excludes lease costs (as under IFRS), add lease liabilities to EV; if lease expense is above EBITDA (US GAAP operating leases), leave them out.
›Do you subtract all the cash?
Usually yes, but some bankers subtract only excess cash and leave the minimum cash the business needs to operate, or exclude restricted cash.
Check yourself
Share price $20, 50 diluted shares, $300 debt, $100 cash. What's enterprise value?
Put it all together
Count every share, run the full bridge, and judge the multiple against peers.