16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means

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CORPORATE FINANCE FINANCIAL RATIOS

Enterprise Value (EV) Formula and What

It Means
By JASON FERNANDO Updated December 14, 2023

Reviewed by DAVID KINDNESS

Fact checked by YARILET PEREZ

What Is Enterprise Value (EV)?

Enterprise value (EV) measures a company's total value, often used as a more
comprehensive alternative to market capitalization. EV includes in its
calculation the market capitalization of a company but also short-term and
long-term debt and any cash or cash equivalents on the company's balance
sheet.

KEY TAKEAWAYS
Enterprise value (EV) measures a company's total value, often used as a
more comprehensive alternative to equity market capitalization.
Enterprise value includes in its calculation the market capitalization of
a company but also short-term and long-term debt and any cash on the
company's balance sheet.
Enterprise value is used as the basis for many financial ratios that
measure a company's performance.

Investopedia / Michela Buttignol

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16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means
Components of Enterprise Value (EV) TRADE
Enterprise value uses figures from a company's financial statements and
current market prices. The components that make up EV are: [1]

Market cap: The total value of a company's outstanding common and

preferred shares
Debt: The sum of long-term and short-term debt
Unfunded pension liabilities (if any): The amount of capital lacking to cover
pension payouts or the amount a company needs to set aside to make
pension payments in an unfunded plan. Can be added market cap if this
value is present.
Minority interest: The equity value of a subsidiary with less than 50%
ownership. It can be added to market cap for EV calculation.
Cash and cash equivalents: The total amount of cash, certificates of deposit,
drafts, money orders, commercial paper, marketable securities, money
market funds, short-term government bonds, or Treasury bills a company
possesses.

Enterprise Value Formula and Calculation

EV = M C + T otal Debt − C
where:
M C = Market capitalization; equal to the current stock
price multiplied by the number of outstanding stock shares
T otal debt = Equal to the sum of short-term and
​

long-term debt
C = Cash and cash equivalents; the liquid assets of
a company, but may not include marketable securities

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To calculate market capitalization—if not readily available online—you would

multiply the number of outstanding shares by the current stock price. Next,
total all debt on the company's balance sheet, including both short-term and
long-term debt. Finally, add the market capitalization to the total debt and
subtract any cash and cash equivalents from the result.

What Does EV Tell You?

Enterprise value (EV) differs significantly from simple market capitalization in
several ways, and many consider it to be a more accurate representation of a
firm's value. EV tells investors or interested parties a company's value and how
much another company would need if it wanted to purchase that company.

There is one other consideration: a company's EV can be negative if the total

value of its cash and cash equivalents surpasses that of the combined total of
its market cap and debts. This is a sign that a company is not using its assets
very well—it has too much cash sitting around not being used. Extra cash can be
used for many things, such as distributions, buybacks, expansion, research and
development, maintenance, employee pay raises, bonuses, or paying off debts.

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16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means

FAST FACT TRADE

Market capitalization is not intended to represent a company's book
value. Instead, it represents a company's value as determined by
market participants.

EV as a Valuation Multiple
Enterprise value is used as the basis for many financial ratios that measure the
performance of a company. For example, the enterprise multiple contains
enterprise value. It relates the total value of a company from all sources to a
measure of operating earnings generated—the earnings before interest, taxes,
depreciation, and amortization (EBITDA).

EBITDA measures a company's ability to generate revenue and is used as an

alternative to simple earnings or net income (in some circumstances). EBITDA,
however, can be misleading because it strips out the cost of capital investments
like property, plant, and equipment. Another figure, EBIT, can be used as a
similar financial metric without the drawback of removing depreciation and
amortization expenses related to property, plant, and equipment (PP&E).

EBITDA Calculation
EBITDA calculates a company's income before interest, taxes, depreciation, and
amortization. EBITDA is calculated using the following formula:

EBITDA = Net Income + Interest Expense + Taxes + Depreciation +

Amortization

EV/EBITDA
The enterprise multiple (EV/EBITDA) metric is used as a valuation tool to
compare the value of a company and its debt to the company’s cash earnings,
less its non-cash expenses. As a result, it's ideal for analysts and investors
looking to compare companies within the same industry.

EV/EBITDA is useful in several situations:

The ratio may be more useful than the P/E ratio when comparing firms with
different degrees of financial leverage (DFL).
EBITDA is helpful in valuing capital-intensive businesses with high levels
of depreciation and amortization.
EBITDA is usually positive even when earnings per share (EPS) is not.

EV/EBITDA has a few drawbacks:

If working capital is growing, EBITDA will overstate cash flows from

operations (CFO or OCF). Further, this measure ignores how different
revenue recognition policies can affect a company's OCF.
Because free cash flow to the firm captures the number of capital
expenditures (CapEx), it is more strongly linked with valuation theory than
EBITDA. EBITDA will be a generally adequate measure if capital expenses
equal depreciation expenses.

EV/Sales
Another commonly used multiple for determining the relative value of firms is
the enterprise value to sales ratio or EV/sales. EV/Sales is regarded as a more
accurate measure than the Price/Sales ratio since it considers the value and
amount of debt a company must repay at some point.

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16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means
It's believed that the lower the EV/Sales multiple, the more attractive—or
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undervalued—the company is. The EV/Sales ratio can be negative when the
cash held by a company is more than the market capitalization and debt value.
A negative EV/sales implies that a company can pay off all of its debts.

Enterprise Value vs. Market Cap

Why doesn't market capitalization properly represent a firm's value? It leaves a
lot of essential factors out, such as a company's debt and cash reserves.

Enterprise value is a modification of market cap, as it incorporates debt and

cash for determining a company's value.

Here's an example: imagine two identical widget manufacturers, Company A

and Company B, have the same stock price of $4.32 per share. Each have 1
million outstanding shares with a market cap of $4.32 million.

Debt and Cash Change the View

Now, imagine Company A has $500,000 in cash and cash equivalents and
$250,000 in total debt. Its EV (total worth) is $4,320,000 + $250,000 - $500,000 =
$4.07 million.

Company B has $1 million in cash and $250,000 in debt. It's EV is $4,320,000 +

$250,000 - $1,000,000 = $3.57 million.

The companies looked identical using market cap, but a much different picture
appears when EV is calculated.

Enterprise Value vs. P/E Ratio

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that
measures its current share price relative to its earnings per share (EPS). The
price-to-earnings ratio is sometimes known as the price multiple or the
earnings multiple. The P/E ratio doesn't consider the amount of debt that a
company has on its balance sheet.

FAST FACT
EV includes debt when valuing a company and is often used in
tandem with the P/E ratio to achieve a comprehensive valuation.

Limitations of EV
As stated earlier, EV includes total debt, but it's essential to consider how the
company's management utilizes the debt. For example, capital-intensive
industries such as the oil and gas industry typically carry significant amounts of
debt, which is used to foster growth. The debt could have been used to
purchase a plant and equipment. As a result, the EV can be skewed when
comparing companies across industries.

This is essential to consider if the company being looked at is undergoing a

merger or acquisition. This is because the acquiring company will need to
account for the amount of debt it is taking on in the merger. Investors can use
this information to evaluate what the merged companies will look like in the
future.

As with any financial metric, it's best to compare companies within the same
industry to better understand how the company is valued relative to its peers.

Example of EV

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16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means
As stated earlier, the formula for EV is essentially the sum of the market value of
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equity (market capitalization) and the market value of a company's debt, less
any cash. A company's market capitalization is calculated by multiplying the
share price by the number of outstanding shares. The net debt is the market
value of debt minus cash. A company acquiring another company keeps the
cash of the target firm, which is why cash needs to be deducted from the firm's
price as represented by the market cap.

Let's calculate the enterprise value for Macy's (M). For its 2021 fiscal year, Macy's
recorded the following: [2]

Macy's Form 10-K, Fiscal Year Ending Jan. 29, 2022

1 # Outstanding Shares 292.4 million

2 Share Price close on 1/28/22 $25.44

3 Market Capitalization $7.44 billion Item 1 x 2

4 Short-Term Debt $0

5 Long-Term Debt $3.30 billion

6 Total Debt $3.30 billion Item 4+ 5

7 Cash and Cash Equivalents $1.71 billion

Enterprise Value $9.03 billion Item 3 + 6 - 7

We can calculate Macy's market cap from the information above. Macy's has
292.4 million outstanding shares valued at $25.44 per share at the end of its
fiscal year (Jan. 29, 2022): [3] [2]

Macy's market capitalization was $7.44 billion (292.4 million x $25.44).

Macy's had short-term debt of $0 and long-term debt of $3.30 billion for a
total debt of $3.30 billion.
Macy's had $1.71 billion in cash and cash equivalents.

Macy's enterprise value is calculated as $7.44 billion (market cap) +

$3.30 billion (debt) - $1.71 billion (cash).

Macy's EV = $9.03 billion

Enterprise value is considered comprehensive when valuing a company

because, if a company were to purchase Macy's outstanding shares for $7.44
billion, it would also have to settle Macy's $3.30 billion in outstanding debts.

In total, the acquiring company will spend more than $10 billion to purchase
Macy's. However, since Macy's has $1.71 billion in cash, this amount could be
added to repay the debt.

How Do You Calculate Enterprise Value?

To calculate market capitalization, multiply the number of outstanding shares
by the current stock price. Next, total all debt on the company's balance sheet.
Finally, add the market capitalization to the total debt and subtract any cash
and cash equivalents from the result.

What Is a Good Enterprise Value?

Enterprise value is a good indicator of a company's total value, but the
EV/EBITDA is a better indicator, demonstrating the total value to actual
earnings. An EV/EBITDA below 10 is considered healthy.

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16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means
What Is Enterprise Value and Why Is It Important? TRADE
Enterprise value shows a company's total value and is generally used in mergers
and acquisitions to evaluate a prospect. You might also see embedded value
used to value life insurance companies, primarily in Europe.
What Is Enterprise Value vs. Market Value?
Enterprise value is the total value of a company, while market value is the value
of its shares on the stock market. Market capitalization is the total value of all
sthares on the stock market.

The Bottom Line

Enterprise value estimates a company's total value, generally used by other
companies when considering a merger or acquisition. Investors can also use EV
to estimate a company's size and worth to help them evaluate their stock
choices. EV is best used with other metrics for valuating a stock. Some popular
ratios are EV/Sales and EV/EBITDA.

Correction—Dec. 17, 2022: The article has been updated from a previous
version that incorrectly omitted debt when describing the formula for
calculating enterprise value. Debt is a necessary element of the formula.

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Related Terms
What Is Enterprise Value-to-Sales (EV/Sales)? How to
Calculate
Enterprise value-to-sales (EV/sales) relates the enterprise value (EV) of a company to its
annual revenue. more

Total Enterprise Valuation (TEV): Definition, Calculation,

Uses
Total enterprise value (TEV) is a valuation measurement used to compare companies with
varying levels of debt. more

EV/2P Ratio: Meaning, Calculation, Example

https://www.investopedia.com/terms/e/enterprisevalue.asp 6/8
16/04/2024, 12:58 Enterprise Value (EV) Formula and What It Means
The EV/2P ratio is a ratio used to value oil and gas companies. It consists of the enterprise
value (EV) divided by the proven and probable (2P) reserves. EV compared toTRADE proven and
probable reserves is a metric that helps analysts understand how well a company's
resources will support its growth. more

Debt-to-Equity (D/E) Ratio Formula and How to Interpret It

The debt-to-equity (D/E) ratio indicates how much debt a company is using to finance its
assets relative to the value of shareholders’ equity. more

Market Capitalization: What It Means for Investors

Market capitalization is the total dollar market value of a company's outstanding shares.
more

Debt-Adjusted Cash Flow (DACF): What it is, How it Works

Debt-adjusted cash flow is used to analyze oil companies and represents pre-tax
operating cash flow adjusted for financing expenses after taxes. more

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