Enterprise value is the theoretical price an acquirer might pay for another firm. In essence, “step into the current owner’s shoes”.
Think of Enterprise Value as the potential takeover price. In the event of a buyout, an acquirer would take on the company’s debt, but would pocket its cash.
A simpler calculation for enterprise value is the equity value plus total debt minus cash. Equity value, or sometimes referred to as market capitalization, is calculated by taking the number of outstanding shares of common stock multiplied by the current price per share.
Enterprise Value considers much more than just the value of a company’s outstanding equity. To buy a company outright, an acquirer would have to assume the acquired company’s debt, though it would also receive all of the acquired company’s cash. Assuming the debt increases the cost to buy the company, acquiring the cash reduces the cost of acquiring the company.
Debt and cash can have an enormous impact on a particular company’s Enterprise Value. For this reason, two companies with the same equity values may have very different Enterprise Values. For example, Company A has an equity value of $5 million, no debt and $1 million in cash which calculates to an enterprise value of $4 million using the formula above. Company B with the same $5 million equity value with $3 million of debt and no cash calculates to an enterprise value of $8 million. Company A would be cheaper to acquire.
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