Meaning Of Enterprise Value
The enterprise value (EV) of a company is a measure of the total value of a company. In addition to a company's market capitalization and any cash on hand, it also includes short- and long-term debt on the balance sheet.
Enterprise value is frequently used as a substitute for the market capitalization of a company's stock. It is frequently brought up in the context of corporate mergers and acquisitions discussions as a means of determining the value of the companies involved.
Enterprise value is a calculation that, in theory, represents the total cost of acquiring a company if that company were to be acquired by a single entity. For a publicly traded company, this would entail the purchase of all of the company's stock, effectively resulting in the company being taken private.
Because it takes into account a number of other important factors, such as preferred stock, debt (including bank loans and corporate bonds), market capitalization, and excess cash, EV provides a more accurate estimate of takeover cost than market capitalization.
Formula Of Enterprise Value
Enterprise Value = Market Capitalization + Total Debt – Cash and Cash Equivalents
Market Capitalization- Equal to the current stock price multiplied by the number of outstanding stock shares
Total debt- Equal to the sum of short-term and long-term debt
Cash and Cash Equivalents- The liquid assets of a company, but may not include marketable securities
Importance of Enterprise Value
It provides information about the company's worth. Or to put it another way, it's a hypothetical takeover price.
It is a representation of a company's economic worth.
It is a hypothetical takeover price for a company that is being purchased because it accounts for both the debt and the cash that the acquirer would pocket as a result of the transaction.
It is useful in comparing and contrasting companies with different capital structures.
When comparing the returns from different businesses, it is possible to see which ones are more interested in acquiring controlling stakes.
It is used by stock market investors to neutralize risks and compare the expected returns on their investments.
Limitations of Enterprise Value
You should be aware of some of the disadvantages of using the enterprise value formula before implementing it. Because enterprise value includes the total amount of debt owed by the company, you'll need to consider how that debt has been utilized by the company. A significant amount of debt is typically incurred by businesses operating in capital-intensive industries, for example, This debt, on the other hand, is used to stimulate economic growth (funding the purchase of equipment, making investments, and so forth). Even though the enterprise value calculation would be skewed against these companies in favor of businesses in low/zero debt industries, it is possible that relying solely on enterprise value will result in you missing the bigger picture.
If the market cap of company is $ 100 M, it had debt of $ 40M and cash and bank balance of $ 10 M, then the enterprise value is calculated as:
EV = 100 + 40 – 10