Enterprise Value (like MVIC) is one measure of total firm value. It is the sum of the market value of all claims against a company’s assets, including claims by equity holders and debt holders. It is a value that is “capital structure independent,” which just means that a change in the company’s capital structure would not affect the enterprise value. The main purpose of EV is for relative analysis, finding relative market comps or related transactions and calculating multiples from them.
Calculating The Enterprise Value of a Public Company
Enterprise Value of a public companyis calculated in the following equation:
Enterprise Value (EV) = Market Value of Equity + Market Value of Debt + Minority Interest – Total Cash
The first two components of this equation are straightforward, they measure what the market believes to be the value of the claims against the company’s assets. The last two terms are less straightforward but have a sound theoretical basis.
GAAP principles require a company that owns more than 50% of another company to consolidate its financial statements with the parent company. This means that if Company A owns 55% of Company Z, Company A would have to roll up 100% of the amount of Commpany Z’s financial statements (income statement, balance sheet, cash flow statements), so it appears that Company A and Company Z are “consolidated” entities. Because the parent company (Company A) does not own 100% of the subsidiary, Company A would have an adjustment to it’s financial statements to reflect the fact that it does not own 100% of Company Z. This adjustment is called a minority interest expense on the income statement and a minority interest on the balance sheet.
So why do we add it to enterprise value?
EV/EBITDA is a typical Enterprise Value multiple. It includes an income statement item in the numerator, and a balance sheet item in the denominator. If a company consolidates the subsidiary into its financial statements, the EBITDA income statement item reflects the operations of both the company and the subsidiary (minority interest expense is below the EBITDA line on the income statements). So in order to do an apples to apples comparison, we would either 1) subtract out the income statement items related to the subsidiary or 2) add the minority interest value to the enterprise value. Option 1 would be very difficult to do unless an analyst had access to the subsidiaries financial statements (which arent always available), so option 2 is preferred.
Cash is typically subtracted from enterprise value because in a transaction, cash on the acquiring company’s balance sheet can be used to pay off debt, or it is a “cash for cash” transaction. Additionally, if cash was not subtracted from the EV calculation, any company with excess cash would skew multiples higher (higher EV = higher numerator, higher multiple).
Calculating The Enterprise Value of a Guideline Transaction
If an analyst is calculating the Enterprise Value of a transaction, he is likely using the data to perform a relative value calculation. The most important rule to follow in calculating an Enterprise Value of a guideline transaction is to make sure that the databases used in the analysis use a consistent measure of Enterprise Value. Some databases use MVIC as a measure of total firm value when calculating multiples, which would leave in either some or all levels of cash the acquired company holds. Other databases may include or exclude any real estate or minority interest. It is important that the analyst makes a determination of firm value and stays consistent throughout his analysis.
Calculating Enterprise Value in the Discounted Cash Flow Approach
The Discounted Cash Flow approach yields intrinsic value of total firm value, as opposed to a relative value we described above in the market approach methods. Typically some measure of cash flow is projected into the future and discounted back to calculate a total firm value. If the cash flow measure includes cash flow available to all owners of the firm (debt and equity) and the rate used to discount cash flow is the weighted average cost of capital, then the sum of the present values of cash flows is the Enterprise Value.