Enterprise Value ( EV )
What is Enterprise Value?
Definition: Enterprise value also known as the firm value which is used to calculate the worth of the company by comparing its stock price, outstanding debt, cash, and equivalent in the event of the company sale.
In other words, enterprise value is used to measure how much company pay for purchasing another company.
For the growth of the company, there are 2 ways. in the first-way company want to reach the new customer for which company makes new products and lines. it is the costly and time taken strategy for the growth of the company. Due to this most of the companies second way for growth.
In the second way of the growth, company search for those companies which are successful in the market and buy those company.
Enterprise value formula can be calculated by adding the debt in market capitalization and subtract the current cash.
Enterprise Value = Market capitalization + debt – current cash
This is the most simple equation of enterprise value which depends on debt and cash. Some time investors analyze the preferred share, minority interest, cash equivalent, liquid inventory, and other investment.
So investors can use this equation for enterprise value which is the more detailed equation.
Enterprise value = (FMV of common and preferred share + debt + minority interest- cash and equivalent)
Now we take the example to better understand the enterprise value
Joe has the music store which he operates for 10 years, now this store approach by guitar centre because of its location. Joe wants to sell his store in $200,000 but he is not comfortable for such business evaluation. Balance sheet values of Joe’s store listed below
- Cash = 50,000 dollars
- Inventory = 15,000 dollars
- liabilities = 25,000 dollars
- common stock = 75,000 dollars
- Retained earning = 15,000 dollars
From these values enterprise value calculated as
35,000 = 75,000 + 25,000 – 50,000 – 15,000
So from the enterprise value method, joe’s store worth calculated $35,000.
What is enterprise value used for?
To find the takeover price of any business or company enterprise value is used. Just like the example above which takeover value calculated by this $35,000 which include the entire business and balance sheet.
It means that guitar centre gets all the cash, inventory, and debt of the store. Due to this enterprise value consider more accurate as compared to the market capitalization method.
Market capitalization ( MC )method consider the shorthand calculation method because it is easy to calculate and for the calculation of this not much research be required.
This look the equity section and the value of the outstanding common share. But this cannot complete the task that how to value a complete business. There are many moving parts in the company and each section of the balance sheet examine for estimate the purchase price.
For more Financial Ratio Check: