An enterprise value is the value of company taken as a whole, i.e., including the market capitalization of the equity as well as the market value of the debt, that it carries on its balance sheet. Thus, in a way, it involves the ownership interests of all the stakeholders including shareholders as well as the debt providers. Hence, it can be considered as theoretical value or an intrinsic value for buying a company.
The enterprise value comprises of the following various elements:
Equity value: It’s the market value of all the equity shares issued by the company. This is obtained by multiplying the total diluted equity shares of the company with the current market price of the equity shares. This alone does not provide us with the accurate value of the company as this is the minimum sum of money which is to be paid to the equity shareholders of a company to only acquire their stake.
The market value of Net Debt: Debt is generally obtained from the banks and other lending institutions are interest-bearing liabilities. A lot of times debt is also obtained by issuing debt instruments to the public at large. Typically, the amount lying in the balance sheet as cash is adjusted from the amount of gross debt, to arrive at the figure of the net debt. This is done because of the reason that when debt is acquired by a buying company, then it will also use the cash acquired to repay the loan up to that extent. Also, if the market value of debt is not known or cannot be arrived at, then the book value of the Debt can be taken for the purpose of calculations.
Preferred shares: These are the instruments which carry the feature of both the debt as well as equities. They are more of the nature of debt as they pay a fixed rate of dividends provided the firm earns profits and have a charge over the assets and earnings of the company above the equity shareholders in case of a liquidation.
Non-controlling interest: A minority interest is the stake, which is owned by the shareholders who doesn’t have the controlling interest over the subsidiary. As the parent company consolidates the whole of the revenue, expenses and the cash flows of the subsidiary although it doesn’t own the whole of it, it must report the stake of minority via a line item in the balance sheet called as the “non-controlling interest.” By including the minority interest, we would be able to incorporate the whole of subsidiary into the calculation of the enterprise value.
Cash & cash equivalents: It is believed that the acquiring company will immediately use this cash to pay off the acquisition cost it has incurred to buy the company. We will reduce this amount from the enterprise value as it will effectively reduce the acquisition cost of buying the target company.
The Enterprise value also frequently called EV is used in relative valuation, i.e. multiple based valuation. The typically used multiples are EV/EBITDA, EV/Sales & EV/FCF. The EV is mainly used over the P/E multiples as the EV incorporates two of the main elements, i.e., debt as well as the cash. Also, the consideration of EV is advantageous in comparing companies, which have varied capital structures, because the enterprise value is an unlevered value and does not get impacted by the kind of capital structure a company has.
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