What is the Enterprise Value?
The Enterprise Value (TEV) of a company represents the value of its operations to all stakeholders, including common shareholders, preferred equity holders, and lenders of debt financing.
Enterprise value quantifies how much the core operating business is worth (i.e. operating assets minus operating liabilities).
- What is the formula used to calculate the enterprise value?
- Which specific capital providers are represented by enterprise value?
- What is the appropriate discount rate that applies to the enterprise value?
- How does enterprise value differ from equity value?
Table of Contents
Enterprise Value Definition
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 simply 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.
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.
That is why enterprise value 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.
Common Enterprise Value Multiples
Note that 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.
Enterprise Value (TEV) Formula
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.
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.
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.
To calculate equity value from enterprise value, 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).
Negative Enterprise Value (TEV)
While a company with a negative enterprise value is an irregular occurrence, it can occasionally occur.
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.
Excel Template Download
Now that we’ve explained the enterprise value (TEV) concept and the components comprised within the metric, we can move on to an example calculation in Excel.
To follow along with the step-by-step tutorial, fill out the form below to download the file.
Enterprise Value Model Assumptions
Let’s get started. Here in our modeling exercise, we’re looking at three different companies that each share the following financial data points.
- Latest Closing Share Price: $50.00
- Total Diluted Shares Outstanding: 200m
With those two assumptions stated, we can calculate that the equity value of all three companies is $10bn.
- Equity Value = $50.00 Latest Closing Share Price x 200m Total Diluted Shares Outstanding
- Equity Value = $10bn
Enterprise Value Calculation Example
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
From the assumptions laid out, we can tell that the capital structure gets more complex from Company A to Company C.
In the case of Company A, since all three assumptions are zero, the enterprise value will be equivalent to the equity value as 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.
The enterprise value for the three companies is as follows:
- Enterprise Value – Company A: $10bn
- Enterprise Value – Company B: $11.5bn
- Enterprise Value – Company C: $14.2bn
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.
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 which means net debt stays the same if all that a company has done is take on more debt.
Read this article for a deeper dive into some of the common misunderstandings surrounding the difference between enterprise value and equity value.