Enterprise value is the value of the operational business, independent of capital structure. This metric is used as an alternative to Market capitalization.
Enterprise Value = Market Capitalization + Debt – Cash
Market Cap of the company is Rs 10000 Cr and the total borrowing (debt) is Rs 1500 Cr and the cash in hand is Rs 500 Cr. The Enterprise value is Rs 11000 Cr.
How to use practically
Enterprise Value is a more potent metric than Market Capitalization
For instance, Company A has Rs 600 Cr in market cap, Rs 200 in cash, and carries no debt.
On the other hand, Company B also has Rs 600 Cr in market cap, but has no cash, and carries Rs 300 Cr of debt.
In this simple scenario, we can see that Company A is cheaper to buy because it doesn’t have any debt to pay off creditors.
Enterprise Value is very useful in Mergers and acquisitions situations. It is useful for comparing companies with different capital structures because a change in capital structure will affect the amount of enterprise value.