Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is an economic measure reflecting the market value of the whole business. It is a sum of claims of all the security-holders: debtholders, preferred shareholders, minority shareholders, common equity holders, and others. Enterprise value is one of the fundamental metrics used in business valuation, financial modeling, accounting, portfolio analysis, etc.
Cash is subtracted because when it is paid out as a dividend, it reduces the net cost to the purchaser. Therefore, the business was only worth the reduced amount to start with. The same effect is accomplished when the cash is used to pay down debt.
Value of minority interest is added because it reflects the claim on assets consolidated into the firm in question.
Value of associate companies is subtracted because it reflects the claim on assets consolidated into other firms.
EV should also include such special components as unfunded pension liabilities, executive stock options, environmental provisions, abandonment provisions, and so on, for they also reflect claims on the company's assets.
EV can be negative in certain cases?for example, when there is too much cash in the company.
A simplified way to understand Enterprise Value is to envision purchasing an entire business. If you settle with all the security holders, you buy EV.
Metrics using EV
EV/EBITDA is the metric most used to measure how many years it would take to pay back the investment. This metric is equivalent to the payback period used by debtholders (Debt/EBITDA). The P/E metric used by shareholders is similar except it measures earnings, not cash flow.
EBITDA/EV is the metric most used to measure the cash rate of return on the investment.
Usage
Because EV is a capital structure-neutral metric, it is useful when comparing companies with diverse capital structures.
Stock market investors use EV/EBITDA to compare returns between equivalent companies on a risk adjusted basis. They can then superimpose their own choice of debt levels. In practice, equity investors may have difficulty accurately assessing EV if they do not have access to the market quotations of the company debt. It is not sufficient to substitute the book value of the debt because a) the market interest rates may have changed, and b) the market's perception of the risk of the loan may have changed since the debt was issued. Remember, the point of EV is to neutralize the different risks, and costs of different capital structures.
Buyers of controlling interests in a business use EV to compare returns between businesses, as above. They also use the EV valuation to determine how much to pay for the whole entity (not just the equity). They may want to change the capital structure once in control.
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