Minty Analyst EOOD

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Enterprise Value (EV) of the Business

A company’s value consists of its owned assets, but in reality, obtaining their market value can
be tedious and resource-intensive. Following the accounting equation, we can value these by
the shareholder’s equity and liabilities, which the company used to finance its assets. By
considering the market value of the firm’s equity and liabilities, we can derive the current
market value of the business.

It helps investment analysts to evaluate potential new investment opportunities. The EV metric
is vital because it’s not affected by capital structure, but only by the core operations of the
business.

To move away from the Market Value of Equity of the business and over to Enterprise Value,
we remove the non-core business assets like cash and short-term investments and add all
liabilities, which are the items that represent all other investors.

Enterprise Value in a Nutshell

To put it simply, Enterprise Value (EV) is a modification of market capitalization (market cap)
that includes debt and cash. It is a useful metric when we perform company valuations. The
metric is also known as Total Enterprise Value and Total Firm Value.

Enterprise Value tells us the worth of the company, which is a theoretical price for taking over
the business, before considering the takeover premium. It accounts for the debt and cash
balances the acquirer will also assume. The metric looks at total market value and is useful to
compare companies with different capital structures. That way, EV considers all shareholder
interests and claims on assets, both from debt and equity.

EV helps capture the total value of the business and is a more accurate and comprehensive
representation. It is the minimum an investor would pay to acquire a company.

The metric helps investors to make appropriate decisions considering the market capitalization,
together with the debt and cash positions of the company. It is a more accurate interpretation
of market cap.

Enterprise Value serves a two-fold purpose:

• To calculate the cost to acquire the whole business;

• A capital neutral valuation to compare companies.
 Minty Analyst EOOD
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mintyanalyst.com

When we evaluate a business with its EV, it is crucial to pay attention to how the company uses
its debt and liabilities. Some firms within capital intensive industries carry lots of debt to
facilitate growth. This will impact the Enterprise Value and make comparisons of such firms to
ones within other industries highly inaccurate. Therefore, it’s usually a good idea to use EV to
compare companies within the same industry.

Enterprise Value Calculation

We calculate the metric with the following formula:

Market Capitalization is the value of the common shares of the company. We derive the
Market Value of Equity by multiplying the total outstanding shares of the company by the
current market price of the stock. If you plan to acquire a company, you need to pay at least the
market cap value. This alone is not an accurate measure of the total cost of the business, so
Enterprise Value considers other components as well.

Preferred stock displays the features of both debt and equity. Preferred shares have a higher
priority in asset claims than common stock, and they pay out a fixed dividend. We treat these
as debt, as they usually have to be repaid in an acquisition.

Debt includes all liabilities of the company. These are interest-bearing loans and borrowings
that represent the contribution to the business by banks and creditors. An acquirer assumes
liability for all debts of the company. Therefore, debt increases the purchasing cost, and we add
to the Enterprise Value calculation. By including debt, which has to be paid by the acquirer, the
EV provides a more accurate takeover value. If there’s no way to determine the market value of
debt, we can use the book value instead. We deduct cash as, in theory, the acquirer can use the
company’s money to cover a portion of this debt.

NCI (or Minority Interest) represents the portion of subsidiaries that is held by the minority
shareholders, meaning the parent entity does not own it. We add it to ensure 100% of the
subsidiary value is in EV. That way, the calculation reflects the parent showing 100% of the
subsidiary performance in its consolidated financial statements, even if owning less than that.

Cash is the most liquid asset and includes cash on hand and in bank accounts, as well as any
highly liquid short-term investments and marketable securities, as we can easily translate these
into monetary funds. We deduct cash from the EV calculation, as it reduces the cost of
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mintyanalyst.com

acquisition. The acquirer can use it either to cover the purchase price or to pay out debt and
dividends.

Looking at the components of the Enterprise Value equation, we can see that Debt and Cash
can have a significant impact on the metric. Two companies might have the same market
capitalization, but if one has more cash or debt, they will have different EV’s.

If the company has cash balances exceeding its outstanding debt, then EV will be below the
market cap. And, vice versa, if the liabilities exceed the cash balance, the market cap will be
higher than the Enterprise Value. EV can also, in theory, be below zero if the business has
retained abnormal amounts of cash.

EV Multiples and Ratios

We often use the Enterprise Value to calculate various multiple ratios, like EV/EBITDA, EV/EBIT,
EV/Sales, EV/FCF. These contribute to great benchmark analysis, as they include the effect of
cash and debt, unlike other ratios like the Price/Earnings ratio, for example.

EV/EBITDA is useful when evaluating capital intensive businesses. We can also use this multiple
to compare firms with different capital structures and different degrees of financial leverage.
When comparing two companies, generally, the one with lower EV/EBITDA multiple is the
better investment opportunity. However, EBITDA can become misleading if there are significant
capital expenditures. EBITDA gives the most accurate results when CAPEX is close to the
depreciation and amortization expenses.

EV ratios give key insights when comparing between companies, even such with significantly
different capital structures.