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What is Enterprise Value?
Enterprise Value (EV) is the measure of the total value of the company. Instead of determining firm’s value based on market capitalization only, it gives the aggregate value of the firm as an enterprise.
In simple words, the Enterprise Value of a company is a theoretical price at which it can be bought. It is significantly different from market capitalization and considers many other factors to arrive at the correct valuation of the business. Like for example, if a firm has some debts and another organization takes it over. In such case, the firm taking over shall take over the debt of the firm too and the same has to be paid by the taking over the firm. The Enterprise Value considers all the factors including the debt; this is not the case while determining the value as per market capitalization method. Thus while sizing up, the investors get to know the actual valuation of the organization.
There is a formula to calculate the Enterprise Value of the private company. Let us have a look at the formula.
Enterprise Value Formula
The Enterprise Value of the firm is calculated with the following formula:
Enterprise Value = Market Capitalization + Debt + Preferred Share Capital + Minority Interest – Cash and cash equivalents
Let us take an example to see the calculation of Enterprise Value
Example of Enterprise Value
Calculate the Enterprise Value of ABC Ltd. from the following data:
Number of Shares Outstanding: 2,000,000
Current Price of the Share: $ 10
Total Cash: $ 1,000,000
Total Debt: $ 200,000
We shall calculate Enterprise Value using the above formula
Enterprise Value = (2,000,000 * $ 10) + $ 200,000 – $ 1,000,000 = $ 19,200,000
Therefore, the Enterprise Value is $ 19,200,000
Let us see why the Enterprise Value is important.
Importance of Enterprise Value
The investors invest in a company when they know its true value. The highest investment comes in those companies that generate higher cash flows along with high enterprise value. Enterprise Value is very critical for the value investors who consider the value of a company beyond the outstanding equity. Debt and cash have a huge impact in finding the correct valuation of a company. Both the components do not form part of market capitalization to find the true value of the company.
On the other hand, the Enterprise Value acknowledges such aspect and helps in finding the actual valuations of the enterprise. To sum up, Enterprise Value helps the investors to know the accurate value of the company and determine whether it is undervalued or not.
Enterprise Value plays a significant role for the investors to find the actual value of the company. It helps in comparison of companies having different capital structures. During the takeover of the company, along with the assets, the liabilities are also taken over. The liabilities include debts and other components. It is obvious that now the debt will have to be paid by the new organization that is taking over the firm. Thus, the actual value of the company comprises of not only market capitalization but also the other components. Going forward the concept of Enterprise Value is going to become more relevant and more organizations as well as investors will opt for this method to know the true value of the company.