Enterprise Value Formula: Meaning, Importance

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Enterprise Value Formula: Meaning, Importance

Enterprise Value Formula: One of the important components of valuation is market capitalization (Mcap) that values the stocks of a company. It is calculated as the share price multiplied by the number of shares a company has outstanding.

Example: If a company has 10 shares and each sells at Rs100, the market capitalization is Rs1,000. This is required to be paid to buy every share of the company. Thereby, it gives more of the price than the value of the company.

In comparison to the market capitalization, on the other hand, modification of market cap that includes debt and cash for valuing a company is defined as the Enterprise Value (EV) or Total Enterprise Value (TEV) or Firm Value (FV)In other words, a more comprehensive, alternative and accurate representation compared to Mcap is the EV, that helps measure the company’s total value. Simply put it is the minimum that someone would pay to buy a company outright.

Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

Enterprise Value Formula Meaning
Enterprise Value Formula Meaning

Market capitalization = value of the common shares of the company
Preferred shares = If they are redeemable then they are treated as debt
Debt = All inclusive of bank loans, bonds which are to be dealt with by the acquirer
Minority Interest = It is defined as the portion of subsidiaries that are held by the minority shareholders.
Cash and Investments = Highly liquid investments, cash in hand, cash at the bank are considered

In the above formula, as the acquirer would be liable for the debts of a company, debt increases the cost of purchasing a company and is, therefore, an addition in the EV calculation formula. On the other hand, cash would be an asset, so it is subtracted in the EV calculation.

Debt and cash have a strong impact on a company’s EV. For example, two companies with the same market capitalizations would have different enterprise values. A company with an Rs500cr market capitalization, no debt, and Rs10cr in cash would be cheaper to acquire than the B company with the same Rs500cr market capitalization, Rs30cr of debt and no cash.

  • Any acquisition of assets through cash of issue of shares increases the EV, whether or not the asset is productive. On the other hand, a reduction in capital intensity, like reduction in the working capital, reduces the EV.
  • EV could also be negative if the company holds abnormally high amounts of cash that may not be reflected in the market value of the stock as well as the market capitalization.

Enterprise Value-Ebitda Multiple Formula

Enterprise multiple, also known as the EV multiple, is a ratio used to determine the value of a company. The enterprise multiple looks at a firm in the way that a potential acquirer would by considering the company’s debt. Stocks with an enterprise multiple of less than 7.5x based on the last 12 months (LTM) is generally considered a good value. However, using a strict cutoff is generally not appropriate because this is not an exact science.

Unlike many other common measures, the enterprise multiple takes into account a company’s debt and cash levels in addition to its stock price and relates that value to the firm’s cash profitability (e.g. the price-to-earnings [P/E] ratio).

  • Enterprise multiple, also known as the EV/EBITDA multiple, is a ratio used to determine the value of a company.
  • It is computed by dividing enterprise value by EBITDA.
  • Enterprise multiples can vary depending on the industry. It is reasonable to expect higher enterprise multiples in high-growth industries and lower multiples in industries with slow growth.

Enterprise Value To Equity Value Formula

Enterprise Value

Enterprise value constitutes more than just outstanding equity. It theoretically reveals how much a business is worth, which is useful in comparing firms with different capital structures since the capital structure doesn’t affect the value of a firm. In the purchase of a company, an acquirer would have to assume the acquired company’s debt, along with the company’s cash. Acquiring the debt increases the cost to buy the company, but acquiring the cash reduces the cost of acquiring the company.

Businesses calculate enterprise value by adding up the market capitalization, or market cap, plus all of the debts in the company. Debts may include interest due to shareholders, preferred shares, and other such things that the company owes. Subtract any cash or cash equivalents that the business currently holds, and you get the enterprise value. Think of enterprise value as a business’ balance sheet, accounting for all of its current stocks, debt, and cash.

Enterprise Value Formula Meaning, Importance
Enterprise Value Formula Meaning, Importance

Equity Value

Equity value constitutes the value of the company’s shares and loans that the shareholders have made available to the business. The calculation for equity value adds enterprise value to redundant assets and then subtracts the debt net of cash available. Total equity value can then be further broken down into the value of shareholders’ loans and (both common and preferred) shares outstanding.

Equity value and market capitalization are often considered similar and even used interchangeably, but there is a key difference: market capitalization only considers the value of the company’s common shares.

Preferred shares and shareholders’ loans are considered debt. By contrast, equity value includes these instruments in its calculation. Equity value uses the same calculation as enterprise value but adds in the value of stock options, convertible securities, and other potential assets or liabilities for the company. Because it considers factors that may not currently impact the company, but can at any time, equity value offers an indication of potential future value and growth potential. The equity value may fluctuate on any given day due to the normal rise and fall of the stock market.

What Is Enterprise Value Formula

The enterprise value of a company can be ideally defined as an amount that represents the entire cost of the company in case some investor intends to acquire 100% of it. The formula for enterprise value is computed by adding the company’s market capitalization, preferred stock, outstanding debt, and minority interest together, and then deducting the cash and cash equivalents obtained from the balance sheet. The cash and cash equivalents are deducted from the enterprise value since the post-acquisition of the complete ownership of the company, the cash balance basically belongs to the new owner. Mathematically, it is represented as,

Enterprise value Formula = Market Capitalization + Preferred stock + Outstanding Debt + Minority Interest – Cash & Cash Equivalents

How Do You Calculate The Enterprise Value?

As stated earlier, the formula for EV is essentially the sum of the market value of equity (market capitalization) and the market value of debt of a company, less any cash. The market capitalization of a company is calculated by multiplying the share price by the number of shares outstanding.

How Do You Calculate Enterprise Value On A Balance Sheet?

You can calculate enterprise value by adding a corporation’s market capitalization, preferred stock, and outstanding debt together and then subtracting out the cash and cash equivalents found on the balance sheet.

Why Do You Subtract Cash In The Enterprise Value Formula?

Cash gets subtracted when calculating Enterprise Value because (1) cash is considered a non-operating asset AND (2) cash is already implicitly accounted for within equity value. Note that when we subtract cash, to be precise, we should say excess cash.

Why Is Debt Added To Enterprise Value?

And that is why you add the debt when calculating the enterprise value of a firm. Enterprise Value: EV represents the entire economic value of a company. It is a measure of the takeover price that an investor would have to pay to acquire a particular firm.