Companies seek “enterprise value” when they require a formula to estimate the value of a publicly traded company. It’s a straightforward valuation indicator that’s frequently the beginning point, and occasionally the finish line, for figuring out how much to give when buying a business or how much you might receive when selling your own.
What is an enterprise value?
Enterprise value (EV), as its name suggests, is the total value of a firm as determined by its funding. The market capitalization of the company’s shares and the cost of paying off debt are included (net debt, or debt minus cash). By combining these two numbers, you can get the business’s enterprise value, which tells you where you need to be to buy it.
A company’s market cap is frequently used to estimate its size. Market capitalization can be easily calculated by dividing the price of a share by the total number of shares (the quantity of common stock a business has issued to investors).
The market cap computation is expanded upon by enterprise value, which also factors in the total cash and debt. This can assist a potential investor in determining the genuine value of a company in comparison to similar-sized companies in the same industry (when it needs to raise cash, that is, how a firm uses equity versus debt ). Additionally, it can demonstrate a business’s overall financial health compared to its rivals.
Methods for estimating enterprise value
this equation can be used to determine the enterprise value (EV):
EV= MC + Total Debt-Cash
Market Cap is MC (the current share price times the number of outstanding shares). Both short- and long-term debt and borrowings are included in the total debt. Cash, which provides for short-term cash equivalents but excludes long-term marketable securities, is all available liquidity for a corporation.
Illustration to compute the Enterprise Value
Here is a quick example of determining the value of an enterprise.
Tesla determines enterprise value (NASDAQ: TSLA). Tesla’s market cap was $730 billion as of the conclusion of the second quarter of 2021, based on the company’s share price on September 20, 2021, and the total number of shares outstanding. After the second quarter, the company had $16.2 billion in cash and cash equivalents and $9.4 billion in total debt. These can help to calculate Tesla’s enterprise value:
EV is equal to $730 billion plus $9.4 billion, less $16.2 billion, or $723 billion.
THE VALUE OF AN ENTERPRISE
When a company is being bought, enterprise value is utilized since the acquiring company will have to take on the debt of its intended acquisition. Since it gets to add cash to its balance sheet, you must deduct some money from the computation while adding debt.
Enterprise value, however, is a valuable tool for investors to determine the actual size of a firm, along with taking into account how the company has used debt. For instance, some high-growth tech firms can appear to be overvalued if you solely consider market cap. The enterprise value, however, may display a much different price than the actual market cap when you believe that they have little to no debt and deduct a sizable pile of cash.
There are disadvantages to look out for. You must consider how the company has used its entire debt because enterprise value includes it. For instance, corporations frequently carry a sizable amount of debt in capital-intensive industries. However, this debt serves as a growth catalyst (funding equipment purchases, making investments, and so forth).