What is Enterprise Value?
Enterprise Value (EV) represents the value of a company’s operations to all stakeholders, such as common equity shareholders, preferred stockholders, and lenders of debt capital.
How to Calculate Enterprise Value (Step-by-Step)
Since enterprise value is the value of the company’s operations to all providers of capital, TEV is considered a “capital structure neutral” metric.
Unlike equity value – otherwise referred to as market capitalization – enterprise value is unaffected by the discretionary financing decisions of the management team.
In effect, enterprise value reflects the value of the core operations of a business – regardless of how it is financed – and thus allows for more accurate comparisons between companies due to being independent of their different capital structures.
Conceptually, enterprise value quantifies how much the core operating business is worth (i.e. operating assets minus operating liabilities) to all stakeholders.
For instance, if a company’s debt-to-equity ratio were to increase after raising more debt capital, its enterprise value should theoretically remain unchanged – despite some minor impacts on the company’s financial statements.
In order to calculate the enterprise value of a company, you start by taking the company’s equity value and then add net debt, preferred stock, and minority interest (i.e. non-controlling interest).
- Step 1 → Our starting point, the equity value (i.e. the “market cap”), represents the value of the entire company to only one group of capital providers, which is the common shareholders.
- Step 2 → Next, while not explicitly broken out, the net debt calculation subtracts any non-operating assets – more specifically, cash and cash equivalents (e.g. marketable securities, commercial paper, short-term investments) – from the total amount of debt and any interest-bearing instruments.
- Step 3 → In the subsequent step, we add the liabilities and equity items representative of the stakes held by all other investor groups, including lenders and preferred equity holders.
Enterprise Value Formula (EV)
The formula to calculate the enterprise value of a company is as follows.
The rationale behind incorporating net debt rather than gross debt is that the cash sitting on a company’s balance sheet could hypothetically be used to pay down outstanding debt if deemed necessary.
Enterprise Valuation: Multiples Analysis
Because of the fact enterprise value is capital structure neutral, the metric is the most widely used measure of value in relative valuation, in which TEV-based multiples are used far more frequently in practice than equity value multiples – especially in the context of M&A.
The most common enterprise value-based multiples are the following:
Like the numerator, the denominator (e.g. EBITDA, EBIT) also represents all stakeholders in a company, as opposed to a single stakeholder group like in the case of net income – whereas TEV/Net Income is not a viable valuation multiple due to the mismatch in the applicable investor groups.
Along the same lines, the enterprise value corresponds to the weighted average cost of capital (WACC), which is the weighted discount rate (i.e. hurdle rate) with all capital providers in mind.
In contrast, the cost of equity is the appropriate discount rate when calculating the equity value.
The key takeaway is that the equity value of a company is the residual value left for common shareholders, whereas the enterprise value represents all capital contributors.
If a company has a negative TEV, that means the company has a net cash balance (i.e. the total cash minus total debt) that exceeds its equity value. While a company with a negative enterprise value is an irregular occurrence, it can occasionally occur.
Enterprise Value vs. Equity Value: What is the Difference?
To calculate equity value from TEV, the reverse calculation should be performed, in which net debt is first subtracted and then all non-common equity claims are deducted (i.e. removing the claims of preferred shareholders).
The image below illustrates the relationship between enterprise value and equity value (i.e. “market cap”).
Enterprise Value Multiple Calculation Example (EV/EBITDA)
One of the most common valuation multiples is the EV/EBITDA multiple, which compares the total value of a company’s operations (EV) relative to its EBITDA.
With that said, EBITDA in valuation multiples is particularly useful for capital-intensive companies, where a significant amount of capital is allocated to the purchase of fixed assets.
Given how D&A is a direct function of a company’s capital expenditures, companies with asset-heavy business models are susceptible to periodic fluctuations in performance that can skew GAAP financial results.
The EV/EBITDA multiple answers the following question, “For each dollar of EBITDA generated, how much are the company’s investors currently willing to pay?”
In order to compute a company’s enterprise value (TEV) using the EV/EBITDA multiple, the company’s EBITDA is multiplied by the EBITDA multiple to arrive at the implied valuation.
