Enterprise Value
Also written EV · Enterprise Value (EV)
What it would cost to buy the whole business — market capitalisation plus debt, less cash — as opposed to market capitalisation, which buys only the equity.
In plain language
If you bought every share of a company, you would own the equity. You would also inherit its borrowings, which you would have to repay, and its cash, which you could keep.
Enterprise value is that full cost: pay for the shares, take on the debt, help yourself to the cash. It is the honest price tag on the business itself, independent of how the previous owners chose to finance it.
How it works
This is why EV is the right numerator for comparing companies with different balance sheets. Two retailers with identical stores and identical EBITDA can have very different market capitalisations purely because one borrowed to expand. Their enterprise values will be much closer, because EV counts the borrowing.
Cash is subtracted because the buyer gets it back immediately — paying Rs 100 crore for a company holding Rs 30 crore of cash costs a net Rs 70 crore.
The formula
Enterprise value = Market capitalisation
+ Total debt
+ Minority interest
+ Preference capital
− Cash and cash equivalents
Most often used as EV ÷ EBITDA.
A worked example
Two hotel chains, identical EBITDA of Rs 400 crore:
| Chain A | Chain B | |
|---|---|---|
| Share price | Rs 500 | Rs 260 |
| Shares | 12 crore | 12 crore |
| Market capitalisation | Rs 6,000 cr | Rs 3,120 cr |
| Debt | Rs 200 cr | Rs 3,100 cr |
| Cash | Rs 400 cr | Rs 100 cr |
| Enterprise value | Rs 5,800 cr | Rs 6,120 cr |
| EV/EBITDA | 14.5× | 15.3× |
On market capitalisation, B looks half the price of A. On enterprise value, B is the more expensive of the two. The apparent discount was entirely Chain B's debt, which any buyer would have to repay.
Why NISM asks about it
Chapters 3 and 10 both use EV, and Chapter 10 sets EV/EBITDA against P/E as relative-valuation multiples. Expect a question giving market capitalisation, debt and cash and asking for EV or EV/EBITDA, and conceptual questions on when EV/EBITDA is the better multiple.
Common exam traps
- Cash is subtracted, not added. This is the single most common sign error in the chapter.
- Never form EV ÷ net profit or EV ÷ EPS. Enterprise value is a whole-firm number; net profit is what is left for equity. Pair whole-firm with whole-firm: EV with EBITDA, EBIT or sales.
- A debt-free company with large cash reserves has EV below its market capitalisation. That is correct, not an error.
- Use total debt, long-term and short-term together.
Check yourself
1.How is Enterprise Value defined in the workbook?
- a)Market capitalisation plus cash and cash equivalents
- b)Value of equity plus value of debt minus cash and cash equivalents
- c)Total assets minus total liabilities
- d)Value of equity plus cash and cash equivalents minus debt
Show the answer
Answer: (b) Value of equity plus value of debt minus cash and cash equivalents
EV = Value of Equity + Value of Debt − cash and cash equivalents.
The intuition: buying a whole business means paying the shareholders and taking on the lenders' claim — but the cash sitting inside the company comes back to you, so it reduces the effective price.
Option D reverses the signs on both debt and cash, which is the most common error and produces two of the wrong answers in any EV numerical. Option C describes net-worth or book value of equity, a balance sheet number that has nothing to do with market value. Option A double-counts cash in the wrong direction.
This definition earns its place in the "important considerations" list at the end of the chapter: EV, and not the market capitalisation, is the true value of the firm for a private owner.
2.On a standalone basis, if market capitalisation is ₹10 lakh, total debt ₹3 lakh and cash ₹4 lakh, the Enterprise Value is:
- a)₹17 lakh
- b)₹13 lakh
- c)₹9 lakh
- d)₹6 lakh
Show the answer
Answer: (c) ₹9 lakh
EV = [Market Value of common equity of the Parent + Market Value of preferred capital of the Parent + Market Value of Debt of the Parent] − (cash, cash equivalents and non-operating/non-strategic financial investments of the parent only).
10 + 3 − 4 = ₹9 lakh.
Option A adds the cash instead of subtracting it, which is the trap.
Why cash is deducted: a business is funded by various sources of capital, however EV focusses only on the capital that is gainfully employed in the business. Cash sitting idle is not employed in the business — an acquirer effectively recovers it on day one.
On the equity input: it is the market value of common equity, not the book value. In the workbook's worked example the balance sheet shows common equity ₹12.5 crore, but the calculation uses market capitalisation = 340 × 10,00,000 = ₹34 crores instead.
And for unlisted components: since it is difficult to obtain fair market value for unlisted securities and bank debt, analyst may use the balance sheet values as a proxy if the fair market value is not available.
The consolidated version additionally includes the value of non-controlling interest and the subsidiary's preferred capital and debt, less the subsidiary's cash and non-operating investments.
3.Why can the P/E, EV/EBITDA and EV/EBIT multiples not be applied to certain companies?
- a)Because they only work for listed companies
- b)Because the multiple cannot be applied where the underlying profit metric is negative
- c)Because SEBI prohibits their use in published research
- d)Because they require at least ten years of financial history
Show the answer
Answer: (b) Because the multiple cannot be applied where the underlying profit metric is negative
These multiples divide a price or enterprise value by a profit metric — earnings, EBITDA or EBIT. They cannot be applied if the underlying profit metric is negative, because a negative denominator produces a figure that is not merely wrong but meaningless.
A related problem the workbook flags: where earnings are much lower than their long-term potential — a company just past a loss-making phase, or in a cyclical trough — the multiples would be too high to be meaningful even when technically positive.
The workbook's own answer for loss-makers is EV/Sales: it "is likely to be a more meaningful metric as sales can never be negative" (p209). Price to Book Value is the other multiple that survives a loss year. It focuses on how much an investor needs to invest to gain a claim on the assets, and the book value stays positive even when the current year's profit does not.
One further caution from the workbook: compare against the industry average and the median, since a single extreme comparable can distort the mean.
Where this is taught
- Series X-A · Chapter 8: Investing in Stocksintroduced here
- Series XIX-A · Chapter 11: Valuationintroduced here
- Series XV · Chapter 3: Terminology in Equity and Debt Marketsintroduced here
- Series XXI-B · Chapter 3: Investing in Stocksintroduced here
- Series XIX-C · Chapter 14: Valuationintroduced here
- Series XIX-E · Chapter 12: Valuationintroduced here
- Series XIX-D · Chapter 11: Valuationintroduced here
- Series XV · Chapter 10: Valuation Principles
Related terms
- Discounted Cash FlowA valuation method that estimates the cash a business will generate in future years and converts each year back to what it is worth today.
- EBITDAProfit from running the business, measured before interest, tax, depreciation and amortisation — so before how the company is funded and how it accounts for its assets.
- Free Cash Flow to EquityThe cash left for shareholders after operating costs, tax, capital expenditure, working capital needs and all payments to lenders — what could be paid out as dividend without harming the business.
- Price to Book ValueShare price divided by book value per share — how many times the accounting net worth of a company the market is willing to pay.
- WACCThe blended after-tax rate a company pays on all its capital, equity and debt weighted by how much of each it uses — and therefore the discount rate for free cash flow to the firm.
- Free Cash Flow to FirmThe cash a business generates before any payment to any provider of capital — discounted at WACC it gives the value of the whole firm, from which debt and other claims are then subtracted.
- Relative valuationValuing an asset from the prices of comparable assets rather than from its own cash flows — quick, intuitive, and dependent on whoever set those comparable prices being right.
- Sum-of-the-partsValuing a conglomerate by valuing each business separately on its own appropriate multiple and adding the results, instead of applying one blended multiple to the group.
- PEG ratioThe price to earnings ratio divided by the expected earnings growth rate — Peter Lynch's way of asking whether a high P/E is justified by the growth behind it.
- Earnings yieldEarnings per share divided by the current market price — the reciprocal of the P/E ratio, expressed as a percentage so that equity can be set directly against a bond yield.
- Price-to-Sales ratioShare price divided by annual net sales per share (or market capitalisation divided by annual net sales) — what investors pay for each rupee of a company's revenue.
- Market approachValuing a business from what the market pays for comparable businesses, using earnings and market multiples rather than the company's own projected cash flows.
- Cost approachValuing a business from its assets less its liabilities — by book value, by what it would cost to replace, or by what it would fetch if broken up and sold.
- Trading CompsRelative valuation using multiples read off current market prices — principally the P/E ratio and the Price to Book Value ratio — as the workbook defines the term.
- Deal CompsRelative valuation using earnings based multiples — chiefly EV/EBITDA and EV/Sales — which the workbook also calls Transaction Comparables.
- Economic profit approachA business valuation approach in which value is the capital presently employed in the business plus the present value of the economic profit it is projected to earn in future.
- Price to Earnings multipleShare price divided by earnings per share — the workbook's most widely used market multiple, and a trading comp an AIF can apply to an unlisted company only through its listed peers.
- IPEV GuidelinesThe international best-practice guidelines for valuing unlisted private equity and venture capital investments at fair value, setting out seven widely used methods for valuing a portfolio company.
- Book Value approachThe first of the three asset-based valuation methods: value the company at the historical carrying cost of its assets and liabilities, giving a book value per share treated as the floor price.
- Equity ValueThe value of 100% of a company's shares — what belongs to equity shareholders after debt and preference capital are deducted from enterprise value. For a listed company, its market capitalisation.
- Replacement Cost ApproachAn asset-based valuation that values a business at what it would cost to replace it as it stands today, including set-up costs — suited to businesses with high entry barriers or setting-up costs.
- Free Cash FlowThe cash a company generates from operations after reinvesting in working capital and routine capital expenditure — the figure a DCF valuation projects for about five years and discounts at WACC.
- Economic Value AddedA company's after-tax operating profit less a charge for the capital employed to earn it — the profit that remains after the providers of capital have been paid what they required.
- Market Value AddedThe difference between the current market value of a firm and the original capital its investors contributed — positive means the firm has added value, negative means it has destroyed it.
- EV/EBITDAEnterprise value divided by EBITDA — a whole-firm valuation multiple that compares what it would cost to buy the business against the cash profit the business generates for all its funders.