Enterprise Value (EV) is the measure of a company’s total value. It looks at the entire market value rather than just the equity valueEquity ValueEquity value can be defined as the total value of the company that is attributable to shareholders. To calculate equity value, follow this guide from CFI., so all ownership interests and asset claims from both debt and equity are included. EV can be thought of as the effective cost of buying a company or the theoretical price of a target company (before a takeover premium is considered).
The simple formula for enterprise value is:
EV = Market Capitalization + Market Value of Debt – Cash and Equivalents
The extended formula is:
EV = Common Shares + Preferred Shares + Market Value of Debt + Minority Interest – Cash and Equivalents
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The value of the company can be derived from the assets it owns. However, obtaining the market value of each and every asset can be quite tedious and difficult. What we could do instead is look at how the assets have been paid for.
The simple accounting equation can serve as a guide by looking at assets as the application of funds and both liabilities and shareholder’s equityBalance SheetThe balance sheet is one of the three fundamental financial statements. The financial statements are key to both financial modeling and accounting. as the sources of funds used to finance those assets. When we say value, we mean the current or market value of the company, so it’s the market value of liabilities and the market value of equity that we consider.
What are the Components of EV?
Equity Value
Equity value is found by taking the company’s fully-diluted shares outstanding and multiplying it by a stock’sStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms "stock", "shares", and "equity" are used interchangeably. current market price. Fully diluted means that it includes in-the-money optionsStock OptionA stock option is a contract between two parties which gives the buyer the right to buy or sell underlying stocks at a predetermined price and within a specified time period. A seller of the stock option is called an option writer, where the seller is paid a premium from the contract purchased by the stock option buyer., warrants, and convertible securities, aside from just the basic shares outstanding.
If a company plans to acquire another company, it will need to pay that company’s shareholders by paying at least the market capitalization value. This alone is not considered an accurate measure of a company’s true value, and for that reason, other items are added to it as seen in the EV equation.
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Total Debt
Total debtDebt ScheduleA debt schedule lays out all of the debt a business has in a schedule based on its maturity and interest rate. In financial modeling, interest expense flows is the contribution of banks and other creditors. They are interest-bearing liabilities and are comprised of short-term and long-term debt. The amount of debt gets adjusted by subtracting cash from it because, in theory, when a company has been acquired, the acquirer can use the target company’s cash to pay a portion of the assumed debt.Fixed Income TradingFixed income trading involves investing in bonds or other debt security instruments. Fixed income securities have several unique attributes and factors that If the market value of debt is unknown, the book value of debt can be used instead.
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Preferred Stock
Preferred stocksCost of Preferred StockThe cost of preferred stock to a company is effectively the price it pays in return for the income it gets from issuing and selling the stock. are hybrid securities that have features of both equity and debt. They are treated more as debt, in this case, because they pay a fixed amount of dividends and have a higher priority in asset and earning claims than common stock. In an acquisition, they normally must be repaid just like debt.
Non-Controlling (Minority ) Interest
Non-controlling interest is the portion of a subsidiary not owned by the parent company (who owns a greater than 50% but less than 100% position in the subsidiary). The financial statements of this subsidiary are consolidated in the financial results of the parent company.
We add this minority interest to the calculation of EV because the parent company has consolidated financial statementsConsolidation MethodThe consolidation method is a type of investment accounting used for incorporating and reporting the financial results of majority owned investments. with that minority interest; meaning the parent includes 100% of the revenues, expenses, and cash flow in its numbers even though it doesn’t own 100% of the business.
By including the minority interest, the total value of the subsidiary is reflected in EV.
Learn more about minority interest in enterprise valueMinority Interest in Enterprise Value CalculationEnterprise Value has to be adjusted by adding minority interest to account for consolidated reporting on the income statement. calculations.
Cash and Cash Equivalents
This is the most liquid asset in a company’s statement. Examples of cash equivalents are short-term investments, marketable securitiesMarketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion., commercial paper, and money market funds. We subtract this amount from EV because it will reduce the acquiring costs of the target company. It is assumed that the acquirer will use the cashCash EquivalentsCash and cash equivalents are the most liquid of all assets on the balance sheet. Cash equivalents include money market securities, banker's acceptances immediately to pay off a portion of the theoretical takeover price. Specifically, it would be immediately used to pay a dividend or buy back debt.
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Why is Enterprise Value Used?
Enterprise Value is often used for multiplesEBITDA MultipleThe EBITDA multiple is a financial ratio that compares a company's Enterprise Value to its annual EBITDA. This multiple is used to determine the value of a company and compare it to the value of other, similar businesses. A company's EBITDA multiple provides a normalized ratio for differences in capital structure, such as EV/EBITDAEBITDAEBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. EBITDA focuses on the operating decisions, EV/EBIT, EV/FCF, or EV/Sales for comparable analysis such as trading comps. Other formulas, such as the P/E ratioPrice Earnings RatioThe Price Earnings Ratio (P/E Ratio is the relationship between a company’s stock price and earnings per share. It provides a better sense of the value of a company., usually don’t take cash and debt into account like EV does. Hence, two identical companies that have the same market cap may have two different enterprise values.
For instance, Company A has $60 million in market cap, $20 million in cash, and carries no debt. Company B, on the other hand, also has $60 million in market cap, but has no cash, and carries $30 million of debt. In this simple scenario, we can see that Company A is cheaper to buy because it doesn’t have any debt to pay off creditors.
Enterprise Value is very useful in Mergers and AcquisitionMergers Acquisitions M&A ProcessThis guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process situations, especially with controlling ownership interests. In addition, it is useful for comparing companies with different capital structures because a change in capital structure will affect the amount of enterprise value.
Applications in Financial Modeling
In financial modelingWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company's financial performance. Overview of what is financial modeling, how & why to build a model., it is common practice to model Free Cash Flow to Firm (FCFFThe Ultimate Cash Flow Guide (EBITDA, CF, FCF, FCFE, FCFF)This is the ultimate Cash Flow Guide to understand the differences between EBITDA, Cash Flow from Operations (CF), Free Cash Flow (FCF), Unlevered Free Cash Flow or Free Cash Flow to Firm (FCFF). Learn the formula to calculate each and derive them from an income statement, balance sheet or statement of cash flows), which is based on the cash flow derived from 100% ownership of all assets and, therefore, determines a company’s Enterprise Value.
As you can see in the example above, row 172 produces Unlevered Free Cash FlowUnlevered Free Cash FlowUnlevered Free Cash Flow is a theoretical cash flow figure for a business, assuming the company is completely debt free with no interest expense. (the same thing as FCFF). From there, the XNPVXNPV Function in ExcelThe XNPV function in Excel should be used over the regular NPV function in financial modeling and valuation analysis to ensure precision and accuracy. The XNPV formula uses specific dates that correspond to each cash flow being discounted in the series. Learn step by step in this guide with examples and sceenshots function is used to calculate Net Present Value, which is the EV in cell C197.
Thank you for reading CFI’s guide to Enterprise Value. To continue advancing your career, these additional resources will be helpful:
Enterprise Value vs Equity ValueEnterprise Value vs Equity ValueEnterprise value vs equity value. This guide explains the difference between the enterprise value (firm value) and the equity value of a business.
Investment MethodsInvestment MethodsThis guide and overview of investment methods outlines they main ways investors try to make money and manage risk in capital markets. An investment is any asset or instrument purchased with the intention of selling it for a price higher than the purchase price at some future point in time (capital gains), or with the hope that the asset will directly bring in income (such as rental income or dividends).
Valuation MethodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions
Balance SheetBalance SheetThe balance sheet is one of the three fundamental financial statements. The financial statements are key to both financial modeling and accounting.
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