Corporate Finance Glossary: Capital Structure, WACC and Enterprise Value

Corporate finance terminology explains how companies finance their operations, allocate capital and divide economic value among investors. Equity value is the market value of shareholders’ claims, while enterprise value adjusts for debt and other relevant claims to describe the value attributable to the operating business under an explicit bridge. WACC estimates a blended financing cost. Each measure answers a different valuation question.

This glossary focuses on financing and claims on a company rather than basic EPS and P/E definitions. It explains debt seniority, leverage, financial covenants, capital allocation and a full enterprise-to-equity bridge. All figures are illustrative; businesses with negative cash, complex minority interests or significant financial assets require more detailed adjustments.

Professional glossary definitions

Capital structure

Capital structure is the mix of financing claims used by a company, commonly including ordinary equity, debt and sometimes preferred or hybrid instruments. Management’s choices affect interest costs, financial flexibility, voting ownership and exposure to distress. An economically appropriate structure depends on cash-flow stability, asset security, growth opportunities, taxes and access to finance rather than one universal debt-to-equity target.

Equity value / market capitalisation

Equity value represents the market price of ordinary shareholder claims, often estimated as current ordinary share price multiplied by the appropriate shares outstanding. Fully diluted equity valuation may require adjustments for options, convertibles and other instruments. Market capitalisation is not equal to the price at which an investor could buy the entire company without affecting the market or paying a control premium.

Enterprise value (EV)

Enterprise value is an analytical bridge from equity value to a broader measure of operating-business value, typically adding debt and certain other claims while subtracting excess cash and non-operating assets. There is no single adjustment list appropriate for every company; leases, minority interests, pensions and associates can matter. EV is useful when comparing metrics such as EBITDA across businesses with different funding mixes.

Net debt

Net debt is commonly interest-bearing debt less cash and selected cash equivalents, under an explicitly stated definition. Not all cash is necessarily surplus or freely distributable: restricted cash and operating liquidity requirements can matter. Lease liabilities, deposits and other obligations can be included or excluded depending on the analytical framework. Inconsistent definitions can distort EV comparisons.

EV-to-equity bridge

An EV-to-equity bridge reconciles operating enterprise value to the value available to shareholders after accounting for debt, preferred claims, minority interests and certain other assets or obligations. The precise direction and signs depend on whether the starting point is an operating enterprise value or a full consolidated business value. Double-counting debt or subtracting cash twice is a common spreadsheet error.

Weighted average cost of capital (WACC)

WACC estimates the weighted cost of long-term funding from equity and interest-bearing debt, with an after-tax adjustment for qualifying interest deductibility in many models. A basic expression is E/(D+E) × Ke + D/(D+E) × Kd × (1−T). It depends on market values, financing assumptions and risks. WACC is not a universally observable fixed hurdle rate printed by an exchange.

Cost of equity

Cost of equity is the return investors require for bearing risk as owners of a company’s residual cash flows. Methods such as capital asset pricing use a risk-free rate, beta and equity risk premium under assumptions that may be uncertain. It is not the same as the company’s actual trailing stock return or reported return on equity. Different models may produce materially different estimates.

Cost of debt

Cost of debt is an estimate of the current required return to lenders for the relevant financing risk, adjusted for maturity, security, seniority and other terms. A historical coupon on an old fixed-rate bond may differ from the yield or financing cost the company faces today. Floating-rate exposures and refinancing needs can make costs change as market rates or credit spreads move.

Debt-to-equity ratio

Debt-to-equity compares a defined debt measure with an equity denominator. Book-equity and market-equity ratios can produce very different figures, and negative book equity can make the ratio hard to interpret. A high ratio does not alone prove imminent insolvency; cash-flow predictability, interest coverage and covenant terms are essential context.

Net debt / EBITDA

Net debt divided by EBITDA is a common leverage indicator for non-financial operating companies. It approximates debt relative to an earnings measure before specified expenses, but EBITDA is not free cash flow and leverage may fluctuate dramatically across the cycle. Compare consistent definitions and consider maintenance capital expenditure, working capital, interest, taxes and liquidity before judging financial sustainability.

Interest coverage

Interest coverage measures earnings or cash flow available relative to financing costs, commonly EBIT divided by interest expense under a simple definition. A ratio of 4× means operating profit is four times recorded interest expense for the measured period, not that all debt can be repaid in four years. Interest expense classifications, lease costs, capitalised interest and seasonal earnings can alter interpretation.

Debt covenant

A debt covenant is a contractual requirement or restriction agreed with lenders, such as a minimum interest coverage ratio, leverage ceiling, limits on additional borrowing or collateral maintenance. Breaching a covenant can trigger remedies even before a borrower misses principal or interest payments, subject to waiver and cure terms. Covenant definitions often differ from public headline ratios.

Seniority and subordination

Seniority describes the priority of claims in the contractual and legal payment structure. Secured lenders may have claims over specific collateral, while unsecured and subordinated claims stand differently in insolvency. Actual recoveries depend on legal entities, guarantees, jurisdictions and asset values. A company’s operating assets can be held in subsidiaries, so an investor must analyse structural subordination rather than rely on one group-level debt figure.

Convertible bond

A convertible bond combines a debt claim with conversion rights into equity under specified terms. Conversion ratio, price, maturity, call protections and issuer credit risk influence valuation. It is not simply an ordinary bond with free upside: the conversion feature affects coupon, principal economics and potential dilution to existing shareholders. Convertible terms can include complex settlement alternatives.

Rights issue and recapitalisation

A rights issue raises equity from existing shareholders or eligible holders under stated terms, potentially improving a stressed balance sheet. Recapitalisation can also involve debt-for-equity exchanges or other changes to capital claims. Even when the company becomes more financially resilient, existing holders can face dilution or economic transfers, depending on subscription terms and who participates.

Return on invested capital (ROIC)

ROIC is an estimate of after-tax operating earnings relative to invested operating capital. Comparing sustainable ROIC with WACC can help assess whether an expansion creates economic value after a capital charge. But the ratio depends on treatment of goodwill, assets, tax and acquisitions. A high ROIC is not sufficient to conclude the equity market price is cheap.

Free cash flow to the firm (FCFF)

FCFF estimates cash flows available to all debt and equity capital providers after operating costs, taxes, reinvestment and working capital, under the specified model. It is commonly discounted at an appropriate WACC to estimate enterprise value. FCFF is different from free cash flow to equity, which considers financing flows. The discount rate must be matched to the cash flow being valued.

Worked example

Suppose a fictional company’s equity market capitalisation is £800 million, interest-bearing debt is £350 million and excess cash is £100 million. Ignoring all other claims for clarity, simplified EV = £800m + £350m − £100m = £1.05 billion. If EBITDA is £150 million, EV/EBITDA = £1,050m/£150m = 7.0×. The figure does not independently establish fair value; peer quality, cash reinvestment, taxes and capital structure matter.

Now assume the firm is 60% financed by equity requiring 10% and 40% by debt costing 5% before tax, with an illustrative 25% marginal tax rate for the interest shield. WACC ≈ 0.60×10% + 0.40×5%×(1−25%) = 7.5%. A project returning a sustained 6% after tax on incremental invested capital would fall below that estimated cost of capital, despite producing positive accounting profit.

For a £200 million debt obligation with £40 million annual EBIT and £10 million annual interest, a simple interest-coverage measure is 4.0×. This is not a debt-repayment timeline or covenant compliance certificate. Loan agreements may define EBITDA, debt and interest differently, and a seasonal cash-flow squeeze could still threaten payments despite apparently satisfactory annual EBIT.

How investors and analysts apply the concepts

Equity analysts distinguish shareholder value from enterprise value before using multiples. A larger EV than market cap is not evidence that a company is ‘worth more than its shares’: it can simply reflect financing claims. When a company reports acquisitions, stock issuance or debt refinancing, update the bridge and the fully diluted share count rather than comparing stale and current denominators.

Credit analysts focus on who is entitled to receive cash first, what assets secure the debt, which legal entities owe the money and when obligations mature. A group can show reasonable consolidated leverage while a debt instrument issued by a weak subsidiary has limited recourse. Review guarantees, covenant definitions, collateral and liquidity facilities alongside headline ratios.

Corporate finance strategy considers the trade-off between tax benefits of borrowing and expected financial-distress costs, agency incentives and flexibility. CFA Institute’s capital-structure framework emphasises that future cash flows are central to value; manipulating the financing mix alone does not produce unlimited economic value.

Common errors and limitations

Enterprise value is not always equity value plus gross borrowings minus every cash balance. The bridge depends on operating versus non-operating assets, minority interests and liabilities. Historical debt coupons do not equal current refinancing costs, and book leverage can differ dramatically from market leverage.

An increase in earnings per share after a share buyback does not prove value creation if the repurchase price was excessive. Financial covenants must be evaluated using the loan agreement’s calculations. ROIC above WACC can be positive for the business while its shares remain overpriced because expectations are already reflected in market value.

Term comparison

Frequently asked questions

What is the difference between enterprise and equity value?

Enterprise value includes adjustments for financing and other claims; equity value represents the shareholder residual claim.

Is WACC a company’s borrowing rate?

No. It blends required returns on equity and debt under an assumed capital structure.

Can a firm have positive EBITDA but face distress?

Yes. Debt service, taxes, investment needs, working capital and liquidity can exceed available cash.

Does issuing more equity always reduce the share price?

Not necessarily. The company receives proceeds, while dilution, pricing and use of cash affect the result.

Are bondholders always equal in liquidation?

No. Legal seniority, security, guarantees and issuer entity influence payment priority.

Sources and further reading

• CFA Institute: Capital Structure
• CFA Institute: Cost of Capital
• CFA Institute: Free Cash Flow Valuation

Related Traders MBA resources: ROIC and WACC worked guide and financial ratios glossary.

General education only, not personalised investment, tax or legal advice. Examples are hypothetical, not market forecasts, and investors can incur losses.