The true purpose of calculating Enterprise Value

Someone buys a 100k house, puts 20k down in equity and takes out a mortgage (debt) on the other 80k. How much do you have to pay for the house if you want to buy it? You pay 100k. You don't just buy out the owner's equity in the house, you have to pay the debt portion too. That's essentially EV.

Its basically if you bought the company at its current market cap what you would pay.

You take on the companies debt so you add it and subtract the cash.

You need it for ratios such as EV/EBIT and EV/EBITDA. You need both the denominator and numerator to reflect the same thing (which is the case here, since both EV and EBITDA are capital structure neutral).

You calculate EV to support your argument. Remember - IB valuation isn't really about "valuing" a company. It's about helping a client achieve the best transcriptional outcome.

So if you are advising a target, you might want to use an EV/EBITDA comparison (among other "valuation" "methodologies") with other companies to support your case that your client is undervalued by the market, and thus the buyer should pay a higher premium over the current stock price.

You usually will have to refinance the target's debt due to change of control covenants.

Last time i checked, Assets= liabilities +owner's equity. I suggest you take a basic accounting class. This is elementary math.

uoft2013:

Hi guys,

Some sources call EV the "price that an acquirer really pays''. But in reality the purchase price is always the stock price plus certain premium. Does it mean that EV is just a 'theoretical price' for the business? If so why do we go through all the trouble gauging a company's EV, especially in an M&A transaction?

Thanks!

My fault if its already been answered, but OP..here is an example:

First - you're correct on the purchase price. Its the market price, plus a "control premium" to acquire all of the equity in a company.

However, when that happens, you consolidate the target onto your balance sheet and (usually) assume all debt and cash.

So, the example:

If you buy your friend, for $100 (say, paid to his parents), but he has $20 in his pocket, your true out of pocket cost is actually $80...the enterprise value".

However, if your friend also has $50 in debt, along with the $20 in equity, you're now assuming all of that debt as well and the EV goes from $80 to $130. YOU'RE the one now responsible to pay for the interest on that debt, and the principal at maturity...it is now your property, along with the stock and cash.

So the use in EV is to show the company if the entirety is to be acquired. If you wanted to buy one stock in Facebook, you'd be paying the market price b/c you're simply acquiring part of the equity. However, when Google decides it wants to own ALL of Facebook, it has to account for that other stuff (the outstnding debt and cash-on-hand) as well.