Enterprise value is an alternative to equity market capitalisation and it is the measurement of the entire company’s value.
It is the actual price that is given for purchasing a company and it is the lowest, minimum value that would have to be paid while purchasing the company. EV is a vital base when it comes to dealing with mergers and acquisitions or when a takeover is going to happen in order to value the company.
What are the different Components involved in Enterprise Value?
This is also known as Market cap and it can be found out by multiplying the outstanding shares with the current stock price of the company
Total debt –
This is the sum of all short term and long term debts present.
Equity value –
This can be found by multiplying the outstanding shares which have been fully diluted with the market price of the stock.
Cash and Cash equivalents –
This includes cash and cash equivalents such as treasury bills, bank accounts, government bonds and more. They are equal to the value of the liquid assets present but marketable securities are not included in them.
Preferred Stock –
This has both debt and equity features as it is a hybrid security. In Enterprise Value it is treated as debt and in case of an acquisition it is paid off just like debt.
It is not owned by any parent company and is a part of a subsidiary. The minority Interest or the non – controlling interest is normally added to the enterprise value.
How is Enterprise Value Calculated?
The basic and simplest formula to calculate it is,
EV = Market Capitalization + The Market Value of Debt – Cash and Equivalents
The extended formula that is used for the calculation of EV is,
EV = Common Shares + The Market Value of Debt Present + Minority Interest + Preferred Shares – Cash and Equivalents
If the market capitalization has not directly been given, it can be found by multiplying the present stock price with the number of outstanding shares available.
Afterwards, all the debt that is on the balance sheet needs to be totalled and this is for both short and long term debts.
The final step is to add the sum of the entire total debt with the market capitalization and deduct cash and its equivalents from the final result.
An example would be,
Number of outstanding shares = $300 million
Current share price = $20
Market capitalization = $6 billion (Outstanding shares * Current share price)
Short term debts = $300 million
Long term debts = $6 billion
Total amount of debt = $6.3 billion (Short term debts + Long term debts)
Cash and cash equivalents = $1 billion
The Enterprise Value = $11.3 billion (Market Capitalization + Total debt – Cash and Cash equivalents)
In total, the company that is acquiring this company will spend $12.1 billion to buy it. As there is $1 billion in cash, this can be utilised to repay the debts.
How do we understand what Enterprise Value is telling us?
EV is significantly different from market capitalization and it is more like the theoretical market price of the company which is to be bought in case of a takeover. The amount it would cost to purchase every share of a business’s preferred stock, common stock and debt would be equated here.
It is a measure of the total value of a business and an accurate depiction of the value of the firm where the debts would also be included when the calculation takes place.
What are the Multiples of Enterprise Value?
EBITDA = The recurring earnings from continuing operations + Interest + Taxes + Amortisation + Depreciation
This metric is utilised in order to compare companies with different types of capital structures.
Business ventures which are capital intensive with high amortization and depreciation levels can be valued with this mumultiple
This is a much more accurate measure as the debt that has to be repaid is also taken into account.
If the EV/Sales multiple is lower, it is considered to be undervalued and is an attractive valuation of the company.
What are the Benefits of Enterprise Value?
- The risk present in the stock market can be neutralised and the expected returns can be compared in an effective manner.
- The target company can be valued and the company’s worth can be found out and this is helpful when it comes to looking for potential acquisitions.
- It provides you with a realistic initial starting measure for how much the cost would be to acquire a company.
- The true size of the business can be easily determined by using Enterprise Value.
- The economic value of a company is represented by it.
- It provides a theoretical price that would be present in case of takeovers if the company gets purchased.
What are the Limitations of Enterprise Value?
- It is difficult to use the EV method when it comes to comparing two companies from different industries.
- The usefulness will not be as much when a growing company is taken and compared to understand whether it is cheaper than other older companies with lesser debts and a higher level of growth.
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