# Enterprise Value: Definition & Formula

Instructor: Douglas Stockbridge

DJ Stockbridge is currently pursuing a Masters degree in Accounting.

In this lesson, we'll discuss enterprise value. This is a popular financial metric that tries to answer the question: how much would it cost me to buy the whole company? We'll also describe the various financial ratios that use enterprise value.

## Widget Inc.

Imagine a fictional manufacturing company called Widget Inc. (WI). After WI's release of the past year's annual financials, newspapers might read, ''Widget Inc. (WI) continues to grow their enterprise value (EV).'' Another article may describe how ''WI is currently trading at an EV/EBITDA multiple of 20x.'' Let's learn what those sentences convey about the widget manufacturer.

## Enterprise Value

Enterprise value is a measure of a company's total value. It captures the price someone would need to pay for the entire company - debt, cash and all. Yes, when one company buys another company, they assume that company's debt. This is a liability that will go on the acquirer's balance sheet. To help them finance the acquisition they use the cash held by the company that will be acquired. For example, if a company pays \$10B for another company that has \$2B of cash in the bank, the true purchase price (without debt consideration) is \$8B. Once they pay the \$10B they immediately get the \$2B back as a 'refund' on their purchase price. Enterprise value tries to capture the value of the entire company, debt, cash and all. It is calculated as follows:

Market Value of Equity + Market Value of Preferred Shares + Market Value of Debt + Minority Interest - Cash = Enterprise Value

Let's unpack each part of the equation:

• Market Value of Equity - This is also known as market capitalization. It measures the market's price for the book value of equity of the firm. This is the price an investor needs to pay to be the sole shareholder of the company. It is calculated by multiplying shares outstanding x per share market price. If the company had 1M shares outstanding and each share traded for \$50, then the market value of equity for that company would be \$50M.
• Market Value of Preferred Shares - Preferred shares are a mix between equity/debt securities. They often pay fixed amounts of interest like debt, but they can have voting rights like equity. Like market value of equity, to calculate this part of the equation we multiply the number of preferred shares outstanding x per share market price.
• Market Value of Debt - Debt includes short-term, current, and non-current bonds/notes outstanding (what the company owes to another party). We can calculate the market price of debt by looking in the public markets at what the debt is currently trading for.
• Minority interest - This is when the company is partly owned by another entity. That other entity needs to own less than 50% of the voting shares to have a 'minority' interest. The entity and company report the value of that minority interest is during each accounting period.
• Cash - This includes available cash, cash equivalents, and short-term investments.

## Enterprise Value for Widget Inc.

Let's calculate Widget Inc.'s enterprise value for 1996 and 2016.

1996: Let's assume the market value of equity was \$114B. There were no preferred shares outstanding. The company held \$1.1B of outstanding debt, there was no minority interest held by a 3rd party. The company had retained \$1.4B of cash. Total enterprise value was:

\$114B + 0 + \$1.1B + 0 - \$1.4B = \$113.7B

Notice, how close it is to equity value because the company did not hold very much debt at that time. And what debt it did hold could be quickly retired by the cash the company held.

2016: Let's assume, market value of equity has grown to \$189B. There are no preferred shares. The company has significantly increased its debt to \$42.2B. There is \$158M of minority interest, and the company holds \$18.2B of cash. Total enterprise value was:

\$189B + 0 + \$42.2B + \$158M - \$18.2B = \$213B

This is the price an entity would need to pay for the whole company.

## Financial Ratios

Analysts pair enterprise value with income statement and balance sheet items to understand the company's profitability and operations. We'll discuss two of the most popular financial ratios.

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