Enterprise Value (EV)
The enterprise value (EV) measures the value of the ongoing operations of a company. It attempts to measure the value of a company's business instead of measuring the value of the company. It is the measure for calculating how much it would cost to buy a company’s business free of its debts and liabilities. It can be thought of as a theoretical takeover price of a company’s business.
The enterprise value is used as an alternative to market capitalization. It is a more accurate estimate of the takeover price of a company than the market capitalization.
The enterprise value is calculated by the following formula:
Enterprise Value = Market Capitalization +Debt +Preferred Share Capital + Minority Interest - Cash and cash equivalents
Let’s discuss these components individually and the reasons why they are included in the calculation of enterprise value.
Market Capitalization: Is the market value of common shares of a company. It is calculated by multiplying the current market price per share by the total number of equity shares of the company.
Debt: Includes the bonds and bank loans. Items such as trade creditors are not included. Ones a business is acquired, its debts become the responsibility of the acquirer. The acquirer will have to repay the debts from the cash flows of the business; therefore, they are added to the calculation of enterprise value.
Preferred Shares: Redeemable preferred shares are in substance debt. They are debt to all intents and purposes. Therefore, the existence of such preferred shares represents a claim on the business that must be factored into enterprise value (EV).
Minority Interest: It is a non-current liability that represents the proportion of subsidiaries owned by minority shareholders.
Cash and Cash Equivalents: These include cash in hand, cash at bank, and the short term investments which are highly liquid and can be easily converted to cash. They are subtracted for the calculation of enterprise value because they serve to reduce the acquisition price.