How to value an enterprise

Enterprise value (EV) is defined as the total value of all the capital that is infused into a company, whether by way of debt or equity. It is calculated by taking the sum of the market value of equity (market capitalisation) and the book value of debt and subtracting the amount of cash available.

Enterprise value is a useful metric for estimating the value of money required by an external investor to take over a company. The reason why cash is subtracted while calculating enterprise value is that such an external investor would have access to the cash of the company. If one were to go a step further, the value of minority shareholders' stake would also have to be included so as to take into account the overall cost of acquiring the subsidiaries as well. Enterprise value can be used to value companies that are still in the early stage of their lifecycle or mature companies which are going through financial difficulties since traditional profit-based metrics cannot be used in such circumstances.

The downside of enterprise value is that it does not take into account the true market value of the capital and therefore, may provide a much higher figure.

Case in point: Future Group
After making consistent losses, the promoters of the Future Group finally decided to throw in the towel and sell their businesses to the Reliance Group for an enterprise value of Rs 24,713 crore. The overall debt that the purchaser had to take over was also about Rs 25,000 crore, which meant that the promoters received no compensation for their equity value.

Also in the series:

Look at the EPS, not just profits

Net profits can be misleading

Which is better: ROE or ROCE?