I know every guide says "debt" is added to enterprise value, but what exactly comprises debt? Is it any long-term liability? Do short term notes count under this definition? Would a credit facility count as a "debt" in thecalculation?
Enterprise Value Formula
Enterprise Value is a metric that attempts to reflect the market value of a firm. It attempts to provide a more accurate valuation that market capitalization when considering mergers and acquisitions. Whilst a firm's market capitalization will indicate share price x share quantity, the firm may have a lot of debt which the acquirer would need to pay off (thereby adding the price of the transaction).
The Enterprise Value calculation is:
- Market Capitalization + Debt + + Preferred Shares - Cash & Cash Equivalents
different valuation metrics including enterprise value, firm value and market cap is worth a read.Professor, Aswath Damodoran provides this handy, if a bit simplistic, diagram for calculating enterprise value. His post on
Types of Debt
Debt is any money borrowed from a 3rd party that has to be paid back. But it's not that simple. There are different kinds of debt.
As @re-ib-ny, a Certified Private Equity Professional - Vice President shares:
There are two types of liabilities: operating and financial. Debt represents any financial liability, which would encompass both notes and credit facility obligations outstanding.
What distinguishes a financial liability from an operating liability? Ask yourself how the liability got on the. If the company owes the liability to an entity who simply gave the company cash for the purpose of earning a return on investment, then the liability is financial (one simple test people use is to ask whether the liability earns a rate of return). If, however, the obligation got there in the course of doing business, then it is operating. So, for instance, accounts payable, accrued expenses, etc. (which are owed to suppliers and trade partners, not lenders seeking a rate of return) are all operating liabilities, not debt.
Short-term notes are essentially short-term bonds sold to investors; the company gets cash and the investors earn interest. Classic debt. Credit facilities are like credit cards for corporations. A bank (or syndicate of banks) will commit to giving a company cash, up to a limit, if requested. The company pays interest on the cash it borrows, as well as a fee on the undrawn amount as consideration for the banks making the capital available. Also classic debt.
Don't forget to include preferred equity and any other fixed obligation ranking senior to the common stock as debt in your enterprise value. Also, make sure to count options (less the proceeds received on exercise), restricted stock, restricted stock units, etc., when your are calculating.
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