Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is an economic measure reflecting the market value of a whole business. It is a sum of claims of all the security-holders: debtholders, preferred shareholders, minority shareholders, common equity holders, and others. Enterprise value is one of the fundamental metrics used in business valuation, financial modeling, accounting, portfolio analysis, etc.

EV is more comprehensive than market capitalization (market cap), which only includes common equity.

EV equation[link]

Enterprise value =

common equity at market value

+ debt at market value

+ minority interest at market value, if any

- associate company at market value, if any

+ preferred equity at market value

- cash and cash-equivalents.

Comments on basic EV equation[link]

• All the components are taken at market—not book—values, reflecting an opportunistic nature of the EV metric. Some proponents argue that debt should be accounted for at book value. This is particularly relevant in liquidation analysis, since using absolute priority in a bankruptcy all securities senior to the equity have par claims. Generally, also, debt is less liquid than equity so that the "market price" may be significantly different from the price at which an entire debt issue could be purchased in the market. In valuing equities, this approach is more conservative.
• Cash is subtracted because when it is paid out as a dividend after purchase, it reduces the net cost to a potential purchaser. Therefore, the business was only worth the reduced amount to start with. The same effect is accomplished when the cash is used to pay down debt.
• Value of minority interest is added because it reflects the claim on assets consolidated into the firm in question.
• Value of associate companies is subtracted because it reflects the claim on assets consolidated into other firms.
• EV should also include such special components as unfunded pension liabilities, employee stock option, environmental provisions, abandonment provisions, and so on, for they also reflect claims on the company's assets.
• EV can be negative in certain cases—for example, when there is more cash in the company than the value of the other components of EV.

Intuitive Understanding of Enterprise Value[link]

• A simplified way to understand the EV concept is to envision purchasing an entire business. If you settle with all the security holders, you pay EV.

Usage[link]

• Because EV is a capital structure-neutral metric, it is useful when comparing companies with diverse capital structures. Price/earnings ratios, for example, will be significantly more volatile in companies that are highly leveraged.

• Stock market investors use EV/EBITDA to compare returns between equivalent companies on a risk-adjusted basis. They can then superimpose their own choice of debt levels. In practice, equity investors may have difficulty accurately assessing EV if they do not have access to the market quotations of the company debt. It is not sufficient to substitute the book value of the debt because a) the market interest rates may have changed, and b) the market's perception of the risk of the loan may have changed since the debt was issued. Remember, the point of EV is to neutralize the different risks, and costs of different capital structures.

• Buyers of controlling interests in a business use EV to compare returns between businesses, as above. They also use the EV valuation (or a debt free cash free valuation) to determine how much to pay for the whole entity (not just the equity). They may want to change the capital structure once in control.

See also[link]

• DCF, discounted cash flow method of valuation
• Capital structure
• WACC, weighted average cost of capital
• Social accounting
• Residual Income Valuation

External links[link]

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