At times, market capitalization alone does not properly represent a company’s total value because it excludes other important factors such as a company’s debt and its cash position which are adjusted for in the EV. Hence, an Enterprise Value (EV) calculation is used in order to measure a firm’s total value.
The formula of a company’s EV can be easily calculated as shown below:
Enterprise Value = Total Market Value of Debt + Total Equity Value + Minority Interest – Cash and Investments
Debt, cash and investments of a company have to be considered when valuing a firm because if a firm (target) is being acquired by another company (acquirer), the buyer has to repay the acquired firm’s debt while absorbing all the cash and investments during the purchase. One example of calculating a company’s EV can be referenced to BlackBerry (NASDAQ: BBRY). In order to calculate BlackBerry’s EV, we simply plug the numbers from the table below into the EV equation:
Enterprise Value = 1,340 + 5,184 + 0 – 1,710 – 1,308 = 3,506 (in USD millions)
|Cash and cash equivalents
|Enterprise Value (EV)
One thing to note is that the market value of debt is not always readily available publicly since current interest rates must be used in order to calculate the market price of debt. Hence, the book value of debt can be used as a substitute to approximate its market value. If BlackBerry were bought over by an acquirer today, the buyer would have to pay its equity value of US$5.184 billion while receiving a total of US$3.018 billion of cash and investments. However, the buyer would also have to absorb BlackBerry’s long-term debt of US$1.34 billion, which could be used to pay down from the company’s cash and investments.
In addition, EV can also be used to calculate the company’s relative value using EBITDA or EBIT to arrive at an EV/EBITDA or EV/EBIT ratio. Both ratios can determine whether the company is overvalued, undervalued or fairly valued to its peers and industry.
Value In Action
The enterprise value can be used to compare companies with different capital structures. Using EV versus the equity value of a company allows an investor a better sense of how much a company might be worth upon acquisition after considering its cash, investments and total debt in its balance sheet.
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie doesn’t own shares in any companies mentioned above.