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Enterprise Value: A More Accurate Way to Value a Company

Enterprise Value (EV) is a financial metric used to assess the total value of a company, taking into account both its equity and debt components. It’s often used as a more comprehensive measure of a company’s worth compared to just looking at its market capitalization (market cap). EV provides a better picture of a company’s total value because it considers not only the equity value that shareholders hold but also the debt and other financial obligations that the company has.

Enterprise value formula

The formula for calculating Enterprise Value is as follows:

EV = Market Capitalization + Total Debt – Cash and Cash Equivalents

Where:

• Market Capitalization: The total value of a company’s outstanding shares in the stock market. It’s calculated by multiplying the current share price by the total number of shares outstanding.
• Total Debt: The sum of all the company’s outstanding debt, which includes loans, bonds, and other forms of borrowing.
• Cash and Cash Equivalents: The total amount of readily available cash and highly liquid assets that the company holds.

The rationale behind subtracting cash and cash equivalents from the total value is that if a company has a significant amount of cash, it can potentially be used to offset a portion of its debt obligations, thus reducing the effective cost of acquisition for a potential buyer.

Enterprise Value is particularly useful in financial analysis and valuation, especially when comparing companies with varying levels of debt or cash on their balance sheets. It’s commonly used to determine the appropriate value for acquisition purposes, as it considers both the equity and debt factors that an acquiring company would need to take into account.

For example lets say a Company has a Market Cap of \$14blIn but had \$4bln of Total Debt and a positive Cash Position of \$2.5Bln.

The EV is \$14Bln + \$4Bln – \$2.5Bln = \$15.5Bln

An acquirer could buy this company outright at the current Market Cap and can pay off the debts by using the cash. They would end up paying \$15.5Bln in total to acquire the Equity, the Debt and Cash.

Enterprise Value limitations

The limitations of enterprise value as a metric are the following:

• It is a backward looking indicator, not giving the analyst any views on future trends
• There is no indication whether debt is used productively or unproductively by the company