Total Enterprise Value - Explained
What is Total Enterprise Value?
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Table of ContentsWhat is Total Enterprise Value?How Does Total Enterprise Value Work?Using the TEV to normalize values
What is Total Enterprise Value?
Total enterprise value is a crucial metric that compares organizations having different debt levels. One can calculate TEV by using the following formula: TEV= market capitalization + interest-bearing debt + preferred stock - excess cash There are many financial experts who prefer using a basic market capitalization analysis for ascertaining a company's worth, but since firms have varying financial structures, total enterprise value tends to be a more effective measure of establishing comparison between firms.
Back to:BUSINESS & PERSONAL FINANCE
How Does Total Enterprise Value Work?
As debt and cash involve a huge effect on the financial position of a company, TEV helps in calculating the complete economic worth of a firm. There can be times when companies having same market capitalizations showcase varying enterprise values because of these effects. (Note: TEV is used in the finance industry for two reasons: to compare firms having varying forms of equity and debt, or to examine a prospective takeover decision) For instance, a company that wants to compare its worth with that of its competitor needs to look besides the concept of market capitalization. Lets assume that the market capitalization of its competitor is worth $100 million with $50 million in the form of debt. And the firm that is comparing the values might have the same market capitalization of $100 million, but with zero debt along with $10 million cash. Using total enterprise value, the worth of competitor would be more based on the debt amount. TEV metric signifies prospective takeover agendas as well as the amount that the company should pay for the acquisition. Continuing with the aforementioned example, lets assume that the company wants to acquire the competing firm instead of comparing its values. As per the market capitalization rate, the value of takeover or acquiring the competing firm would be $100 million. However, if the concept of TEV is used, the cost of takeover would increase to $130 million including cash and debt. This turns out to be a better price for the firm.
Using the TEV to normalize values
Besides making comparison and prospective acquisitions, the company uses TEV for normalizing the firms valuation. Besides market capitalization, there are many financial analysts who use price-to-earning ratio for arriving at a company's worth. Though there are possibilities that the P/E ratio may not offer complete information about the company's financial status. It considers market capitalization and profitability of the firm that makes equity more expensive in comparison to other firms, which is not the case in reality. One can normalize the valuation of a firm by considering the earnings before interest, tax, depreciation, and amortization (EBITDA) to-enterprise value instead of the price-to-earnings ratio. This ultimately offers a proper evaluation of stock prices of public firms. Key points to remember
- Total enterprise value is a tool used for comparing firms with different degrees of debt.
- TEV is the summation of market capitalization, interest-bearing debt, preferred stock, which is then subtracted by excess cash.
- TEV helps in taking decisions related to prospective takeovers and the price of acquiring a firm.
- TEV enables to ascertain the complete worth of a firm in economic terms.