Enterprise Value Made Easy

Enterprise Value

Definition of Enterprise Value

A company's enterprise value is equal to market cap, plus debt, minus cash. Just as a quick refresher market cap is equal to stock price times the number of shares outstanding. A company's enterprise value measures the total company value, whereas the market cap only measures the equity value.

A company's enterprise value is also the theoretical takeover price in an M&A deal. Let me elaborate on both of those concepts.

Example: Home Purchase

Using an example of a home purchase, let's say you buy a home for a million dollars. You finance that with $750000 in debt in the form of a mortgage and you put in $250000 of your own money. We don't say that the home is worth $250000, even though that's what you put in. The home is worth what you put in plus what the bank put in the home price or the home value is $1 million.

When we think about enterprise value, that's the true value of the business. And when we look at businesses, we care about the entire value of the business, regardless of, I would say in quotes, who put in the money.

M&A Deal

What do I mean by the theoretical takeover price in an M&A deal? Let's say an acquire is buying a target. It has to not only buy out the equity holders, but it also have to pay. It also has to pay down its debt. Now, even if it doesn't pay down the debt, it assumes that liability and therefore it is a form of compensation.

Subtracting Cash

Now, why do we subtract cash? The way to think about that is if a company was acquiring a target, it could use that cash to offset the purchase price. Another way to think about it is that cash could be used to pay down debt. So when you think about debt, you think about net debt. Enterprise value is equal to market cap plus net debt. Net debt being debt minus cash.

Example: Proctor & Gamble

Now let's do an example using Procter and Gamble. Let's calculate the simple formula for enterprise value. And later in this tutorial, we'll use an expanded formula. So for Procter and Gamble, I have to first find its stock price.

So I do PG stock price. And I got one seventeen seventy nine.

Next, I need to get the shares outstanding. I'm going to do that. I go into its latest quarterly report or annual, if that's what the most reason was taking the share count.

From the bottom of the first page, like we did in the market cap tutorial. I'm going to multiply the shares by the stock price. And what I'm going to do is divide that by a million. So this is in millions. Next, I need to go to the balance sheet and add cash and subtract debt.

So scrolling down to the balance sheet here, I see that cash and cash equivalents is fifteen thousand, which is really 15 billion because the amounts are in millions go to put that in over here. And that's also in millions.

And so that was cash. 15,393.

And then let's put in debt.

For debt, we need to take the short term debt that due within a year, so 12 7 0 1 and add in any long term debt. Twenty three, three, ten.

Let's calculate the enterprise value market cap, plus debt, minus cash. The enterprise value and all these are in millions. The enterprise value is three hundred and twelve billion dollars.

The market cap, which measures the equity value, is two hundred ninety one billion dollars. But the total company value is slightly bigger because the company has is in a net debt position, meaning its debt is greater than its cash.

Expanded Definition of EV

Let's look at an expanded definition of enterprise value. Enterprise value is really equal to market cap plus debt and other claims like debt minus cash and other access assets. I'm just expanding upon the definition we had earlier.

Now, debt would not only be debt, it would also include preferred stock. Minority interest and underfunded pension liabilities and cash would not only include cash, it would include cash, short term investments, maybe even long term investments or anything.

That's an excess asset, meaning that asset is not needed to run its business. Using that expanded definition, we would also include the preferred stock.

So that's nine hundred.

And when I say nine hundred is really nine hundred million and minority interest or non-controlling interest for 0 one and I calculate enterprise value as market cap plus debt plus other things like that minus cash.

And that's the full or expanded form of enterprise value.

Market Cap & EV

Now, another important way to think about this is if I flip around the formula, what do I get? I would get a market cap equals enterprise value minus debt plus cash. Why do I bring this up? People always ask why do I add debt to get to value? Doesn't value decrease if you have that?

Well, the way to think about it is the total company value is higher, but not the equity value. If I think about it like this, my equity value is equal to the total value, minus debt plus cash. It makes a lot more sense.

Simple Example

Let's do an example. Let's say the TV was equal to 5 million. Total debt is 2 million and cash is 1 million.

What is the equity value? Well, I start with the total company value. I subtract the debt and other similar liabilities and then I add back cash.

Looking at the formula that way for many people makes it a lot more intuitive.

Recap

In summary, the enterprise value of a company measures the total company value where market cap only measures the equity value. Enterprise value is calculated as market cap plus debt and other liabilities minus cash and other access assets. Those other liabilities that are typically included or treated as debt are mainly preferred stock. Minority interest and underfunded pension liabilities. For more on those terms as well as a review of market cap. See our related finance tutorials.

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