Definition
Enterprise value is quite simply the price that a purchaser would be expected to pay to make an outright purchase of a target company. Outright purchase means that the intention of the purchaser must be to acquire 100% ownership without any other claims on the properties of the company.
How Enterprise Value is calculated?
Market capitalization
(the market worth of the outstanding shares)
+
Secured and unsecured debt
(this is to make the properties of the target company free from any claims)
+
Minority interest
(percentage of a subsidiary not owned by the target company)
+
Preference shares
(which carry a fixed dividend and are, therefore, regarded as akin to debt)
- (minus)
Cash
(which, after acquisition, becomes available to the purchaser)
Implications
Enterprise value tells us the worth of a company and facilitates comparison of the values of different businesses that may be on the radar of a purchaser.
Ultimately, what needs to be kept in mind is that the value is largely derived from the liability side of the balance sheet. It is, therefore, important to ensure that the assets that are being acquired are productive and that the earnings from the company will be worth the price to be paid.
