Enterprise value 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

Business valuation

Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to consummate a sale of a business...

, financial modeling

Financial modeling

Financial modeling is the task of building an abstract representation of a financial decision making situation. This is a mathematical model designed to represent the performance of a financial asset or a portfolio, of a business, a project, or any other investment...

, accounting, portfolio

Portfolio (finance)

Portfolio is a financial term denoting a collection of investments held by an investment company, hedge fund, financial institution or individual.-Definition:The term portfolio refers to any collection of financial assets such as stocks, bonds and cash...

 analysis, etc.

EV is more comprehensive than market capitalization

Market capitalization

Market capitalization is a measurement of the value of the ownership interest that shareholders hold in a business enterprise. It is equal to the share price times the number of shares outstanding of a publicly traded company...

 (market cap), which only includes common equity.

EV equation

Enterprise value =

common equity at market value

Market value

Market value is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may differ in some...

+ debt

Debt

A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

 at market value

+ minority interest

Minority interest

Minority interest in business is an accounting concept that refers to the portion of a subsidiary corporation's stock that is not owned by the parent corporation...

 at market value, if any

- associate company

Associate company

An associate company in accounting and business valuation is a company in which another company owns a significant portion of voting shares, usually 20–50%. In this case, an owner does not consolidate the associate's financial statements. Ownership of over 50% creates a subsidiary, with its...

 at market value, if any

+ preferred equity at market value

- cash

Cash

In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...

 and cash-equivalents.

Comments on basic EV equation

• 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
  Employee stock option
  An employee stock option is a call option on the common stock of a company, issued as a form of non-cash compensation. Restrictions on the option attempt to align the holder's interest with those of the business shareholders. If the company's stock rises, holders of options generally experience a...
  
  , 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

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

Usage

• Because EV is a capital structure
  Capital structure
  In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
  
  -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
  EV/EBITDA
  EV/EBITDA is a valuation multiple used in finance and investment to measure the value of a company. This important multiple is often used in conjunction with, or as an alternative to, the P/E ratio to determine the fair market value of a company.An advantage of this multiple is that it is capital...
  
   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
  Capital structure
  In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
  
   once in control.

See also

• DCF
  Discounted cash flow
  In finance, discounted cash flow analysis is a method of valuing a project, company, or asset using the concepts of the time value of money...
  
  , discounted cash flow method of valuation
• Capital structure
  Capital structure
  In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
  
  
• WACC
  Weighted average cost of capital
  The weighted average cost of capital is the rate that a company is expected to pay on average to all its security holders to finance its assets....
  
  , weighted average cost of capital
• Social accounting
  Social accounting
  Social accounting is the process of communicating the social and environmental effects of organizations' economic actions to particular interest groups within society and to society at...