A company's enterprise value is typically much higher than its equity value because the former includes assets that are not readily convertible to cash, such as long-term debt.
In addition, a company's assets may have residual value after they are sold, generating more value above and beyond the cash they can provide to shareholders.
Equity valuation considers only the worth of a company's shares outstanding; enterprise value includes both equity and non-equity components.
Why is enterprise value so much higher than equity value?
The difference between enterprise value (EV) and equity value
There is a common confusion between enterprise value (EV) and equity value. Equity value is what shareholders would receive if a company were to liquidate.
Enterprise value includes the equity value, debt, and other obligations of the company. This makes EV a more accurate measure of how much it would cost to buy a company outright.
For example, Company A has an equity value of $1 million and owes $500,000 in debt.
The enterprise value of Company A would be $1.5 million. The buyer would have to pay off the debt and buy the equity.
There are a few reasons why EV is essential to consider when valuing a company. It feels like all of a company's liabilities, not just the equity. This is important because debt can be risky for buyers.
What is enterprise value?
Enterprise value (EV) is a measure of a company's total value that considers its equity and debt. It is calculated by subtracting the company's net debt from its market capitalization.
EV can be used to compare companies with different levels of debt or to assess a company's ability to take on new debt. It is also useful for comparing companies of different sizes, as it adjusts for differences in equity values.
EV is an important metric for investors and analysts as it provides a snapshot of a company's financial health.
Why is enterprise value higher than equity value?
When a company is publicly traded, the company's equity value is what shareholders can expect to receive if they were to sell all of their shares.
The enterprise value is what someone would pay for the entire company, including debt and other liabilities.
Often, the enterprise value is higher than the equity value, meaning that the company is worth more than the sum of its parts.
There are a few reasons why this might be the case. For one, a company's debt may be worth more than its equity.
Investors may be willing to pay more for a company with stable, predictable cash flows to collect interest payments on the debt.
Another reason is that a company's assets may be worth more than its liabilities.
For example, a company may own a valuable patent or real estate property that would be difficult to replicate.
How to calculate enterprise value
When valuing a company, a few different measures can be used. The enterprise value (EV) is calculated by taking the market capitalization and subtracting the net debt.
This gives a complete picture of the company's value, including both equity and debt.
The EV could be used to compare companies with different debt levels or to see how much a company would be worth if it were to go bankrupt and liquidate its assets.
It can also be used for investment decisions, as it shows how much money an investor would need to spend to control a certain percentage of the company.
The advantages of using enterprise value
When deciding whether or not to purchase a company, investors and acquisition professionals often use enterprise value (EV) to measure the deal's attractiveness.
Enterprise value is calculated as the market capitalization plus debt, minus cash and cash equivalents.
This figure can be used to benchmark different companies and transactions, and it can also help in determining a company's worth.
There are several advantages of using enterprise value when assessing a potential acquisition:
EV considers all aspects of a business, including liabilities and assets.
EV is less affected by accounting distortions than other measures, such as book value or earnings.
EV can be used to compare companies with different levels of debt and equity.
EV is an essential tool for calculating the return on investment for an acquisition.
Conclusion
Enterprise value is much higher than equity value because it considers a company's debt and other liabilities. It is a more accurate measure of a company's worth and is used by analysts and investors to decide where to invest their money.