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Enterprise Value (TEV)

Guide to Understanding the Enterprise Value (TEV) Concept

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Enterprise Value (TEV)

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.

  • 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

The formula to calculate the enterprise value of a company is as follows.

Enterprise Value (TEV) = Equity Value + Net Debt + Preferred Stock + Minority Interest

The rationale behind incorporating net debt rather than gross debt is that the cash sitting on a company’s balance sheet could be used to pay down the outstanding debt, hypothetically at any time, if deemed necessary.

Importance of Enterprise Value in Corporate Finance

Enterprise value is capital structure neutral, which is why it 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 TEV-based valuation 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 (“Market Cap”)

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).

Equity Value = Enterprise Value Net Debt Preferred Stock Minority Interest
The image below illustrates the relationship between enterprise value vs. market cap.
Enterprise Value vs. Equity Value ("Market Cap")

EV to EBITDA Valuation Multiple

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.

EV/EBITDA Multiple = Enterprise Value ÷ EBITDA
Enterprise Value = EBITDA × EV/EBITDA Multiple

Enterprise Value Calculator – Excel Model Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

Submitting ...

Step 1. Equity Value Calculation (“Market Cap”)

Suppose we’re looking at three different companies with identical share prices, as well as share counts.

With those two assumptions stated, we can calculate that the equity value of all three companies is $10 billion.

  • Equity Value = $50.00 Latest Closing Share Price x 200 million Total Diluted Shares Outstanding
  • Equity Value = $10 billion

Step 2. Capital Structure Assumptions (and Net Debt)

In the prior step, we calculated the equity value and we now just need the remaining assumptions to calculate the enterprise value of each company.

Company A Financials

  • Net Debt = $0m
  • Preferred Equity = $0m
  • Minority Interest = $0m

Company B Financials

  • Net Debt = $1bn
  • Preferred Equity = $500m
  • Minority Interest = $20m

Company C Financials

  • Net Debt = $3bn
  • Preferred Equity = $1bn
  • Minority Interest = $200m

Given the assumptions above, the company’s capital structure gets increasingly more complex from Company A to Company C.

Step 3. Enterprise Value Calculation Example

In the case of Company A, since all three assumptions are zero, the enterprise value will be equivalent to the equity value of an all-equity firm.

With all the necessary data listed, we can input each assumption into our model and calculate the enterprise value for each company, as shown below.

Enterprise Value Calculator

The implied enterprise value for the three companies is as follows:

  • TEV, Company A = $10 billion
  • TEV, Company B = $11.5 billion
  • TEV, Company C = $14.2 billion

These three companies, despite having the same equity value, have very different operating values (i.e. enterprise values).

More specifically, the value of Company C’s core operating business is $4.2bn greater than Company A’s.

Step 4. TEV Calculation Interpretation and Analysis

Compared to the equity value, the enterprise value (TEV) is closer to the real value of a company since the valuation metric accounts for all ownership stakes, rather than just that of equity owners.

At this point, a common misunderstanding occurs: Students will look at the spreadsheet above and may ask themselves:

  • “Why on earth does adding debt or preferred equity increase a company’s enterprise value?”

Well, the short answer is that it doesn’t! Recognize that adding debt also brings cash onto the books, meaning that the net debt stays the same if all that a company has done is take on more debt.

For further clarification, read the following article for a deeper dive into some of the common misunderstandings surrounding the difference between enterprise value and equity value.

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