Enterprise value
Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is a market value measure of a company from the point of view of the aggregate of all the financing sources; debtholders, preferred shareholders, minority shareholders and common equity holders. Because EV is a capital structure-neutral metric, it is useful when comparing companies with diverse capital structures.
Enterprise value = common equity at equity value + debt at market value + minority interest at market value, if any + preferred equity at market value - cash and cash-equivalents.
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.
Metrics using EV
EBITDA is the measure of cash returns that accrue to all the shareholders in aggregate. The corresponding measure of income would be Net Income with the after-tax cost of interest backed out.
- EV/EBITDA is the metric most used to measure how many years it would take to payback 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
Stock market investors use EBITDA/EV to compare returns between equivalent companies on a risk adjusted basis. They can then super-impose their own choice of personal debt levels. In practice, stock investors cannot use EV because they have no access to the market values 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.
