# Enterprise Value: Definition & Formula

## Enterprise Value

The **enterprise value** (**EV**), also called firm value or total enterprise value, is a valuation method used to calculate the total market value of a company. It is considered an alternative to the equity market capitalization method, which values a given company based on its equity value or the market value of its traded shares. The EV measures the value of a company while considering the value of short-term debt, long-term debt, cash, and cash equivalents. This includes all ownership interests and asset claims from both shareholders and borrowers.

### Uses of Enterprise Value

Managers and financial analysts needs to identify what is enterprise value of a given company before a potential takeover. In other words, this method is used to calculate the effective cost of buying the company, which is also called the theoretical price that values a potential takeover. In addition to that, financial analysts calculate enterprise values to identify the real value of companies. When relying only on the market capitalization, or the total value of traded stocks, the company's value might be misleading as it does not include important factors such as debt.

## 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 Formula

To calculate the value of a firm, the **enterprise value formula** should be used:

$$EV = Common \,Shares + Preferred \,Shares + Market \,Value \,of \,Debt + Minority \,Interest - Cash \,and \,Cash \,Equivalent $$

Where:

- Common Shares: This refers to the total market value of common shares traded in the stock market. By definition, a common share or common stock is a security that represents ownership in the business organization;
- Preferred Shares: This is the total market value of preferred shares traded in the stock market. Preferred shares, or preferred stocks, are shares that also represent ownership in a corporation. However, preferred shares are quasi-debt/equity securities with more advantages than common shares. For instance, in the case of bankruptcy, preferred shares get paid before common shares. Also, holders of preferred shares receive fixed dividends, which is not always the case for holders of common shares;
- Market Value of Debt: This equals the sum of the short-term and long-term debt of the company;
- Minority Interest: Also called non-controlling interest, minority interest refers to the value of the ownership position that is less than 50% in another entity, which is not enough to exercise operational control over this company;
- Cash and Cash Equivalent: This figure refers to the company's most liquid assets (e.g., cash).

### Example:

Calculate the EV of company XYZ given the following data:

- Number of outstanding shares 100,000;
- Market value of each share = $23;
- The total value of debt = $630,000;
- The value of total minority interest = $90,000;
- Total cash and cash equivalents = $30,000;
- Company XYZ has no outstanding preferred shares.

First, the value of common shares is the number of outstanding shares multiplied by the market price per share. This equals 100,000 * $23 = $2,300,000.

Using the enterprise value formula:

EV = $2,300,000 + $630,000 + $90,000 - $30,000 = $2,990,000

## Equity Value

**Equity value** refers to the value remaining to shareholders, after all short-term and long-term debts are paid off. The market value of equity is calculated by multiplying the market price of one share by the total number of outstanding shares. But the book value of equity is calculated as the total assets minus the book value of liabilities. The following section will identify the link between equity value and enterprise value. In addition to that, the next section also highlights the difference between these two valuation methods.

### Enterprise Value and Equity Value

It is important to note that equity value is converted to enterprise value by adding the value of debt and minority interests and deducting cash and cash equivalents. While both methods are used to value the worth of companies, each one is used in a different context. For the enterprise value, it values the company based on all its core business operations. It includes the value of the company available to equity holders and borrowers. The equity value only provides the total value of a company available to equity investors.

Both valuation methods can be used to generate financial ratios. However, each metric or financial ratio has its own interpretations. For instance, using the enterprise value, both the EV/EBITDA and EV/Sales multiples can be calculated. For the EV/EBITDA multiple, the EBITDA refers to the earnings before interest, taxes, depreciation, and amortization, which is an alternative measure of financial performance other than the net income. The EV/EBITDA, referred to as the enterprise multiple indicates whether a company is undervalued or overvalued. Usually, if this ratio is lower than a competitor's, it indicates that the company is undervalued. Hence, the higher this ratio, the more expensive the company is. The EV/sales measures the company's value relative to its annual sales. If this ratio is lower than 1.0, it indicates that sales are higher than the EV, and vice versa.

## Limitations of the Enterprise Value Calculation

Before using the EV, it is essential to understand how debt is used in the company or the industry in general. Since the enterprise value calculation includes short-term and long-term debt, the EV for capital intensive companies will be extremely high. In addition to that, if the company is stimulating rapid growth and invests massively in assets, the EV will be high or even be overvalued. Therefore, the EV is skewed against companies with debt more than those without debt.

## Lesson Summary

The **enterprise value** (**EV**), also referred to as firm value or total enterprise value, measures the total market value of a company. This method is used to calculate the effective cost of a company for a potential takeover. Financial analysts also calculate the EV of companies to identify their real value, as the market capitalization ignores important factors such as debt. The total enterprise value can be calculated using the **enterprise value formula**:

$$EV = Common \,Shares + Preferred \,Shares + Market \,Value \,of \,Debt + Minority \,Interest - Cash \,and \,Cash \,Equivalent $$

Where:

- Common shares refer to the total market value of common shares, where common shares are securities that represent ownership in the company;
- Preferred shares refer to the total market value of preferred shares traded in the equity market. Preferred shares, or preferred stocks, are quasi-debt/equity securities with more advantages than common shares. First, preferred shares pay fixed dividends. Second, in the case of bankruptcy, preferred shares get paid before common shares;
- Market value of debt, which is short-term debt plus long-term debt;
- Minority interest refers to the value of the ownership position in another entity of less than 50%;
- Cash and cash equivalent are the most liquid assets of the company.

The **equity value** measures the company's value available to shareholders. To be converted to the enterprise value, the value of debt and minority interest should be added, while cash and cash equivalent should be subtracted. The enterprise value can be used to generate ratios such as EV/EBITDA and EV/Sales. For EV/EBITDA (where EBITDA is earnings before interest, tax, depreciation, and amortization), it indicates whether the company is expensive for not as the higher this ratio, the more expensive is the company. But for the EV/Sales ratio, it measures the enterprise value relative to annual sales. If the resulted EV/Sales ratio is lower than 1.0, it indicates that sales are higher than EV and vice versa.

## 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.

### Enterprise Value / Earnings Before Interest Taxes Depreciation & Amortization ((EV / EBITDA)

We have already addressed Enterprise Value. EBITDA is a rough estimate of the cash the company generates. An Enterprise Value of $100M and EBITDA of $10M gives a ratio of 10x. Put another way, it will take the company 10 years if it continues to generate cash at the same level until its total return equals the price it paid. Buying the whole company costs $100M. Each year the investor earns $10M. After 5 years, they have earned $50M in total. After 10 years, they have earned $100M, equal to their initial investment.

A high EV/EBITDA ratio means a company is more expensive because it will take many years before the investor has earned in total what he/she paid for the company. Conversely, a low EV/EBITDA ratio means a company is relatively cheap. We calculated the 2016 EV for Widget Inc's at $213B, and let's say their EBITDA was $10.65B. Their EV/EBITDA ratio was then $213B/$10.65B = 20x. It will take Widget Inc. investors 20 years to earn back their purchase price.

### Enterprise Value / Sales (EV / Sales)

EV/Sales is another common ratio used by analysts. Like EV/EBITDA, the higher the ratio, the more expensive the company, all else being equal. The opposite is also true. The lower the ratio, the less expensive. In 2016, Widget Inc's enterprise value was $213B and let's say their sales were $50B. Their EV/Sales ratio would then be 4.26x.

## Lesson Summary

In this lesson, you learned analysts calculate **enterprise value** to measure how much someone would need to pay for an entire company. The equation to calculate enterprise value is:

*market value of equity + market value of preferred shares + market value of debt + minority interest - cash*

Two financial ratios that analysts often talk about, the **EV/EBITDA** and **EV/Sales**, can show how many years it will take investors to earn back their purchase price.

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## 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.

### Enterprise Value / Earnings Before Interest Taxes Depreciation & Amortization ((EV / EBITDA)

We have already addressed Enterprise Value. EBITDA is a rough estimate of the cash the company generates. An Enterprise Value of $100M and EBITDA of $10M gives a ratio of 10x. Put another way, it will take the company 10 years if it continues to generate cash at the same level until its total return equals the price it paid. Buying the whole company costs $100M. Each year the investor earns $10M. After 5 years, they have earned $50M in total. After 10 years, they have earned $100M, equal to their initial investment.

A high EV/EBITDA ratio means a company is more expensive because it will take many years before the investor has earned in total what he/she paid for the company. Conversely, a low EV/EBITDA ratio means a company is relatively cheap. We calculated the 2016 EV for Widget Inc's at $213B, and let's say their EBITDA was $10.65B. Their EV/EBITDA ratio was then $213B/$10.65B = 20x. It will take Widget Inc. investors 20 years to earn back their purchase price.

### Enterprise Value / Sales (EV / Sales)

EV/Sales is another common ratio used by analysts. Like EV/EBITDA, the higher the ratio, the more expensive the company, all else being equal. The opposite is also true. The lower the ratio, the less expensive. In 2016, Widget Inc's enterprise value was $213B and let's say their sales were $50B. Their EV/Sales ratio would then be 4.26x.

## Lesson Summary

In this lesson, you learned analysts calculate **enterprise value** to measure how much someone would need to pay for an entire company. The equation to calculate enterprise value is:

*market value of equity + market value of preferred shares + market value of debt + minority interest - cash*

Two financial ratios that analysts often talk about, the **EV/EBITDA** and **EV/Sales**, can show how many years it will take investors to earn back their purchase price.

To unlock this lesson you must be a Study.com Member.

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#### What is enterprise value and why is it important?

The enterprise value is a method used to calculate the real value of a company. In addition to considering the market value of equity, debt, minority interests, cash, and cash equivalents are also included in its calculation. The enterprise value is important as it enables calculating the real worth of a company before a takeover. It is also calculated by financial analysts to identify to real value of the company as the equity value ignores some important factors such as debt. Finally, the enterprise value is used to generate various ratios, also called multipliers (e.g., EV/Sales).

#### How do you calculate the enterprise value?

The enterprise value is calculated using the following formula:

EV = Common shares + Preferred shares + Market Value of Debt + Minority Interest - Cash and Cash Equivalents

Where:

EV is the enterprise value;

Common shares refer to the total market value of common shares traded in the equity market;

Preferred shares refer to the total market value of preferred shares traded in the equity market;

Market value of debt is the sum of short-term debt and long-term debt of the company;

Minority interest refers to the total value of ownership positions other entities (less than 50% of shares in each);

Cash and cash equivalents are the most liquid assets for the company.

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