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How to Value a Company
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# Enterprise Value (EV)

## What Is Enterprise Value (EV)?

Enterprise value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. EV includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company's balance sheet. Enterprise value is a popular metric used to value a company for a potential takeover.

### Key Takeaways

• Enterprise value (EV) is a measure of 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 as well as any cash on the company's balance sheet.
• Enterprise value is used as the basis for many financial ratios that measure the performance of a company.
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## Formula and Calculation for Enterprise Value (EV)

﻿ \begin{aligned} &EV=MC+Total~Debt-C\\ &\textbf{where:}\\ &MC=\text{\small Market capitalization; equal to the current stock}\\ &\text{\small price multiplied by the number of outstanding stock shares}\\ &Total~debt =\text{\small Equal to the sum of short-term and}\\ &\text{\small long-term debt}\\ &C=\text{\small Cash and cash equivalents; the liquid assets of}\\ &\text{\small a company, but may not include marketable securities}\\ \end{aligned}﻿

To calculate the market capitalization if not readily available 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) could be thought of like the theoretical takeover price if a company were to be bought. 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. The value of a firm's debt, for example, would need to be paid off by the buyer when taking over a company. As a result, enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation.

Why doesn't market capitalization properly represent a firm's value? It leaves a lot of important factors out, such as a company's debt on the one hand and its cash reserves on the other. Enterprise value is basically a modification of market cap, as it incorporates debt and cash for determining a company's valuation.

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. An enterprise multiple that contains enterprise value relates the total value of a company as reflected in the market value of its capital from all sources to a measure of operating earnings generated, such as earnings before interest, taxes, depreciation, and amortization (EBITDA).

EBITDA is a measure of 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 is calculated using the following formula:

EBITDA = recurring earnings from continuing operations + interest + taxes + depreciation + amortization

The enterprise value/EBITDA metric is used as a valuation tool to compare the value of a company, debt included, to the company’s cash earnings less non-cash expenses. It's ideal for analysts and investors looking to compare companies within the same industry.

EV/EBITDA is useful in a number of situations:

• The ratio may be more useful than the P/E ratio when comparing firms with different degrees of financial leverage (DFL).
• EBITDA is useful for 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 also has a number of drawbacks, however:

• 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.

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 takes into account the value and amount of debt a company must repay at some point.

Generally, the lower the EV/sales multiple, the more attractive or undervalued the company is believed to be valued. The EV/sales ratio can actually be negative at times when the cash held by a company is more than the market capitalization and debt value, implying that the company can essentially be by itself with its own cash.

## P/E Ratio vs. EV

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 also 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.

However, 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 Using EV

As stated earlier, EV includes total debt, but it's important to consider how the debt is being utilized by the company's management. 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 be used to purchase plant and equipment. As a result, the EV would be skewed for companies with a large amount of debt as compared to industries with little or no debt.

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

## Example of EV

As stated earlier, the formula for EV is essentially the sum of the market value of equity (market capitalization) and the market value of debt of a company, less any cash. The market capitalization of a company is calculated by multiplying the share price by the number of shares outstanding. 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 2020 fiscal year, Macy's recorded the following:

We can calculate Macy's market cap from the information above. Macy's has 308.5 million outstanding shares valued at $20.22 per share: • Macy's market capitalization was$7.79 billion (308.5 million x $20.22). • Macy's had short-term debt of$452 million and long-term debt of $4.41 billion for a total debt of$4.86 billion.
• Macy's had $1.58 billion in cash and cash equivalents. Macy's enterprise value is calculated as$4.806 billion (market cap) + $4.86 billion (debt) -$1.58 billion (cash).
Macy's EV = $8.086 billion Enterprise value is considered comprehensive when valuing a company because, if a company were to purchase Macy's outstanding shares for$4.8 billion, it would also have to settle Macy's outstanding debts.

In total, the acquiring company will spend closer to $10 billion to purchase Macy's. However, since Macy's has$1.3 billion in cash, this amount can be added to repay the debt.

## What Is Enterprise Value and How Does It Differ From Market Capitalization?

Enterprise value is a popular measurement of the total value of a company. It can be seen as the theoretical price that would need to be paid in order to fully acquire a company in a going-private transaction. Unlike market capitalization, which reflects only the value of the company’s equity, enterprise value reflects the size of the company’s debts as well as its cash reserves. It is a popular figure among investors and analysts and is often used in financial ratios.

To understand why cash is deducted from enterprise value, suppose that you are a private investor wishing to purchase 100% of a publicly-traded company. When planning your purchase, you note that the company’s market capitalization is $100 million, meaning you will need$100 million to buy all the shares from its existing shareholders. But what if the company also has $20 million in cash? In that scenario, your real “cost” for purchasing the company would only be$80 million, since buying the company would immediately give you access to its $20 million in cash. All else being equal, a higher cash balance leads to a lower enterprise value, and vice-versa. ## Why Is Debt Added to Enterprise Value? Higher debt leads to a higher enterprise value because it represents an added cost that must be paid by any would-be acquirer. For instance, in our previous example, suppose that the company has$10 million in debt. With that in mind, you now know that in addition to the $100 million you need to purchase the shares from its existing shareholders, you also need an additional$10 million to pay off the company’s debts. Putting these figures together, your total enterprise value would be $100 million in market capitalization, plus$10 million in debt, minus $20 million in cash, for a total of$90 million.

Correction—March 12, 2022: A previous version of this article quoted incorrect numbers from the Macy's 10-K filing.

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1. Macy's. "Form 10-K For the Fiscal Year Ended January 30, 2021," Page 23.