Enterprise value (EV) is the total value of the firm, reflecting the market value of the entire business. It is calculated as under:
Enterprise Value = Market Capitalisation + Debt (secured and unsecured) + Minority Interest + Preference share capital - Cash and cash equivalents
E.g.: If the market cap of company is Rs. 100 crore, it had debt of Rs. 40 crore and cash and bank balance of Rs. 10 crore, then the enterprise value is calculated as: EV = 100 + 40 – 10 crore = Rs. 130 crore
Enterprise value is a more accurate representation of the value of a firm as compared to other metrics like market capitalization. It can be considered as the value a theoretical buyer would have to bear. Hence, market cap. and debt are added but the cash is pocketed by the prospective buyer. It is due to this reason that Enterprise value is often used in value investing multiple.
While deciding on the best stocks to buy, we often compare the stock of one company to the stock of another company in the stock market. This is known as peer comparison. In this method, enterprise value is often used. For example, multiples such as EV to EBITDA are used along with other multiples like P/E ratio. P/E ratio may be influenced by multiple factors such as taxation, depreciation method, individual characteristics but enterprise value ignores and focuses on the core value and hence is preferable in many cases.