Valuing Nonoperating Assets  337
In general, a nonoperating asset is any asset that you have not incorporated 
as part of free cash flow. Common nonoperating assets are excess cash, one-time 
receivables, investments in nonconsolidated companies (also known as equity 
investments and by other names), excess pension assets, discontinued opera-
tions, and financial subsidiaries. Take extra care not to classify an asset required 
for ongoing operations as nonoperating. For instance, some analysts who follow 
retailers add the value of real estate to the value of core operations. Since the 
real estate is required to conduct business, its benefits are already embedded 
in the value of operations. The value of real estate can only be added to core 
operations if the company is charged a market-based rent in free cash flow. Oth-
erwise, including the value of real estate will lead to an overestimate of value.
Nonequity claims are financial claims against enterprise value whose ex-
penses are not included in EBITA and consequently are excluded from free 
cash flow. Traditional debt contracts like bank debt and corporate bonds are 
the most common nonequity claims. Other debt-like claims, known as debt 
equivalents, include the present value of operating leases, unfunded pension 
and other retirement liabilities, and environmental remediation liabilities, 
among others. Because these claims do not scale with revenue or can affect 
the cost of capital, they are best valued separately from free cash flow.
Nonequity claims also include hybrid securities, such as preferred stock, 
convertible securities, and employee options, which have characteristics of 
both debt and equity. Such hybrids require special care: their valuations are 
highly dependent on enterprise value, so you should value them using op-
tion-pricing models rather than book value.3 Finally, if other shareholders 
have noncontrolling interests against certain consolidated subsidiaries, de-
duct the value of the noncontrolling interests to determine equity value. Like 
hybrid securities, noncontrolling interests will correlate with enterprise value, 
so extra care is required.
Valuing Nonoperating Assets
Although not included in free cash flow, nonoperating assets still represent 
value to the shareholder. Thus, to arrive at enterprise value, you must estimate 
the market value of each nonoperating asset separately and add the resulting 
value to the DCF value of operations. If necessary, adjust for circumstances 
that could affect shareholders’ ability to capture the full value of these assets. 
For example, if the company has announced it will sell off a nonoperating 
asset in the near term, deduct the estimated capital gains taxes (if any) on the 
asset from its market value. If ownership of the asset is shared with another 
company, include only your company’s portion of the value.
3 For investment-grade companies, the value of debt is driven mostly by interest rates. In this case, there 
will be little interdependence between enterprise value and debt. For distressed companies, default 
risk also drives the value of debt. In this case, interdependence will be high and must be modeled. We 
discuss highly levered companies later in the chapter.