1. From Firm Value to Stock Price

We know from earlier on that the overall market value of the firm (enterprise value) is equivalent to the market value of net debt plus the market value of equity:

 

Firm value = Market value of net debt + Market value of equity.

 

Consequently, we can subtract the value of the firm's net debt from the enterprise value to obtain the value of the equity:

 

Market value of equity = Firm value - Market value of net debt.

 

The previous chapters have shown how to estimate enterprise value. Therefore, the only additional item we need to know to estimate the equity value is the value of the firm's net debt. In most instances, book values provides a reasonable approximation of the (market) value of net debt:

 

Market value of net debt ≈ Book value of net debt = Financial liabilities - Excess cash. 

 

Therefore, we can obtain an estimate of the market value of equity by subtracting the book value of all interest-bearing liabilities net of excess cash from our estimate of enterprise value.

 

Example: Let's assume that we have estimated an enterprise value of 100 million. Moreover, we know that the firm in question has interest-bearing liabilities with a book value of 20 million and holds excess cash of 5 million.

Based on this information, the firm's net debt is 20 - 5 = 15 million

Consequently, the market value of the firm's equity is 85 million:

 

Market value of equity = Enterprise value - Book value of net debt = 100 - 15 = 85 million.

 

Now we are ready to estimate the firm's theoretical stock price. We obtain this number by dividing the market value of equity by the number of shares outstanding:

 

Stock price = \( \frac{\text{Market value of equity}}{\text{Number of shares outstanding}}\).

 

Example: Suppose the firm from the previous example has 5 million shares outstanding. Given a market value of equity of approximately 85 million, this implies a theoretical stock price of 17:

 

Stock price = \( \frac{\text{Market value of equity}}{\text{Number of shares outstanding}} = \frac{85}{5}=17.0\).