Enterprise Value - EV
Enterprise value is the total value of a business which equals the sum of its market capitalization (i.e. total market value of equity), market value of non-controlling interest (i.e. minority interest), market value of preferred stock and market value of debt minus the value of cash and cash equivalents.
Enterprise value is most relevant in determining the total investment required to be made by an acquiring company in a target company. It is a more comprehensive measure of a company’s value than its equity value. The market capitalization, i.e. the total market value of equity doesn’t give a complete picture of the value of business because it doesn’t account for value derived using preferred stock and debt capital. Enterprise value includes market values of all the components of capital. The value of cash and cash equivalents is subtracted during calculation of enterprise value because that cash can be directly used to pay off a portion of debt.
Enterprise value multiples such as EV/EBITDA and EV/Sales are some popular relative-valuation ratios.
Enterprise value can be determined using the following equation:
Enterprise Value (EV) = VE + VP + VD - C
Where VD is the market value of equity, it equals the current stock price of the company multiplied by total number of outstanding shares of common stock, VP stands for the market value of preferred stock, VD stands for market value of debt and C stands for cash and cash equivalents.
Wakanda Extraction, Inc. is a company engaged in mining Vibranium. Work out the company’s enterprise value using the following information:
|Total number of shares of common stock||20,000,000|
|Current price of a share of common stock||$45|
|Number of shares of 7% preferred stock||500,000|
|Face value of a share of preferred stock||$1,000|
|Current yield on preferred stock||6.80%|
|Book value of long-term debt||$300,000,000|
|Market value of long-term debt||$295,000,000|
|Book value of short-term debt||$36,000,000|
|Market value of short-term debt||$35,000,000|
|Marketable securities with less than 3 months maturity||$5,000,000|
To determine the company’s enterprise value, we need to work out market values of equity, preferred stock and debt. The market value of equity is straight-forward, it market capitalization
VE = 20 million × $45 = $900 million
To find the market value of preferred stock, we need to work out the price of preferred stock:
|Price of Preferred Stock =||$1,000 × 7%||= $1,029.41|
VP = 200,000 × $1,029.41 = $205.9 million
We need to include the market value of total debt (not their book values):
VD = $295 million + $35 million = $330 million
We need to subtract the value of cash and cash equivalents to arrive at the enterprise value. Total value of cash and cash equivalents works out to $8.5 million
EV = $900M + $205.9M + $330M − $8.5M = $1,427.4 million
Wakanda Extraction’s enterprise value amounts to $1.43 billion. You can see that it is quite different than its equity value which is just $0.9 billion.