How is enterprise value defined?

How is enterprise value defined?

• A. Total assets minus total liabilities.
• B. Market value of equity plus debt minus cash.
• C. Market capitalization plus cash and equivalents.
• D. Shareholder equity plus long-term debt.

Answer: (B)

Enterprise value shows the total value of a business to all providers of capital, basically the price to acquire the entire company. It adds what equity holders would receive (the market value of equity) to the obligations the company has to lenders (debt), and then subtracts the cash on hand. The idea is you can use the company’s cash to pay down debt, so cash lowers the net cost of buying the business. That’s why the correct approach is to take equity value plus debt and subtract cash. It reflects how buyers would finance an acquisition and what cash would offset from the purchase price. Other options miss this adjustment: net assets resembles equity on the balance sheet rather than the acquisition value; adding cash to market cap ignores debt; and combining equity with long-term debt without accounting for cash or other liabilities doesn’t give the true net cost of buying the firm. This measure is also why EV is used in valuation multiples like EV/EBITDA.

Enterprise value shows the total value of a business to all providers of capital, basically the price to acquire the entire company. It adds what equity holders would receive (the market value of equity) to the obligations the company has to lenders (debt), and then subtracts the cash on hand. The idea is you can use the company’s cash to pay down debt, so cash lowers the net cost of buying the business.

That’s why the correct approach is to take equity value plus debt and subtract cash. It reflects how buyers would finance an acquisition and what cash would offset from the purchase price. Other options miss this adjustment: net assets resembles equity on the balance sheet rather than the acquisition value; adding cash to market cap ignores debt; and combining equity with long-term debt without accounting for cash or other liabilities doesn’t give the true net cost of buying the firm. This measure is also why EV is used in valuation multiples like EV/EBITDA.