Posted by Enterprise Value –
Enterprise value is nothing but the actual value of a company. It can be calculate by adding market cap and total debt and substracting cash or cash equivalent.
Enterprise Value = Market cap + Total Debt – Cash and Cash Equivalent
The difference between market cap and enterprise value is market cap calculate only equity side but enterprise value calculate all equity, debt, and cash.
Enterprise value can be used for acquisition and mergers or take overs. EV provide better accurate estimate for acquisitions or take overs. EV is also used for ratio calculations as it provides better estimates.
Let’s take an example of company A,
Market cap = Rs 100cr
Total Debt = Rs 10cr
Cash = Rs 3cr
Then Enterprise value of company A is
EV = Market cap + Total Debt – Cash
EV = 100cr + 10cr – 3 cr
EV = Rs 107cr
Now take an example of company B,
Market cap = Rs 100cr
Total Debt = Rs 25cr
Cash = Rs 7cr
Then Enterprise value of company B is
EV = Market cap + Total Debt – Cash
EV = 100cr + 25cr – 7cr
EV = Rs 118cr
Now you can see in both examples, Market cap of both companies are same but EV is different because debt and cash are different.
Now we will talk about formula, why we are adding market cap with debt and substracting cash, so basic thing is whenever we have to buy a company we have to pay their equity value also we have to pay the debt of company, that’s why we add debt with market cap because we have to pay for both equity and debt. Now let’s talk about cash, if that company has some cash then the cash is going to be ours, that’s why we substract the cash from that.
Let’s take an example, if you have to purchase a shop, the shop has equity value of Rs 100, the shop has to pay Rs 30 as debt and it has cash of Rs 20 in the shop. Then much you would pay Rs 110 right?
You have to pay equity value and debt so that become Rs 130 and the shop has already Rs 20 in shop, so you already got Rs 20 in your hand so you will substract Rs 20 and EV of shop become Rs 110.
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