Relative valuation: -

DEFINITIONof'EnterpriseValue(EV)

EnterpriseValue,orEVforshort,isameasureofacompany'stotal
value, often used as a more comprehensive alternative to
equitymarketcapitalization.Themarketcapitalizationofacompany
is simply its share price multiplied by the number of shares a
company has outstanding. Enterprise value is calculated as the
market capitalization plus debt, minority interest and preferred
shares, minus total cash and cash equivalents. Often times,
theminorityinterest and preferred equity is effectively zero,
althoughthisneednotbethecase.
EV=marketvalueofcommonstock+marketvalueofpreferred
equity+ market value of debt + minority interest cash and
investments.

BREAKINGDOWN'EnterpriseValue(EV)'

Enterprisevaluecanbethoughtofasthetheoreticaltakeoverpriceif
the company were to bought. In the event of such a buyout, an
acquirerwouldgenerallyhavetotakeonthecompany'sdebt,but
wouldpocketitscashforitself.EVdifferssignificantlyfromsimple
marketcapitalizationinseveralways,andmanyconsiderittobea
moreaccuraterepresentationofafirm'svalue.
Thevalueofafirm'sdebt,forexample,wouldneedtobepaidbythe
buyerwhentakingoveracompany,thusenterprisevalueprovidesa
muchmoreaccuratetakeovervaluationbecauseitincludesdebtin
itsvaluecalculation.

EnterpriseValueAsanEnterpriseMultiple

Enterprise multiplesthat contain enterprise valuerelate the total

valueofacompanyasreflectedinthemarketvalueofitscapital
fromallsourcestoameasureofoperatingearningsgenerated,such
asEBITDA.
EBITDA= recurring earnings from continuing operations +
interest+taxes+depreciation+amortization

The EnterpriseValue/EBITDAmultiple ispositivelyrelatedtothe

growth rate in free cash flow to the firm (FCFF)and negatively
relatedtothefirm'soverallrisklevelandweightedaveragecostof
capital(WACC).
EV/EBITDAisusefulinanumberofsituations:
The ratio may be more useful than the P/E ratio when
comparingfirmswithdifferentdegrees

offinancialleverage(DFL).
EBITDA is useful for valuing capitalintensive businesses
withhighlevelsofdepreciationandamortization.
EBITDA is usually positive even when earnings per share
(EPS)isnot.
EV/EBITDAalsohasanumberofdrawbacks,however:
If working capital is growing, EBITDA will overstate cash
flowsfromoperations(CFOorOCF).Further,thismeasureignores
howdifferentrevenuerecognitionpoliciescanaffectacompany's
CFO.
Because free cash flow to the firmcaptures the amount of
capital expenditures (CapEx), it is more stronglylinked with
valuation theory than EBITDA. EBITDA will be a generally
adequatemeasureifcapitalexpensesequaldepreciationexpenses.
Anothercommonlyusedmultiplefordeterminingtherelativevalue
offirmsistheenterprisevaluetosalesratio,orEV/Sales.EV/sales
isregardedasamoreaccuratemeasurethanthePrice/Salesratio
sinceittakesintoaccountthevalueandamountofdebtacompany
has,whichneedstobepaidbackatsomepoint.Generallythelower
the EV/sales multiple the more attractive or undervalued the
company is believed to be.The EV/sales ratiocan actually be
negativeattimeswhenthecashheldbyacompanyismorethanthe
marketcapitalizationanddebtvalue,implyingthatthecompanycan
essentiallybebuyitselfwithitsowncash.

Estimating market value of debt

The market value of debt is usually more difficult to obtain
directly, since very few firms have all their debt in the form of
bonds outstanding trading in the market. Many firms have non-

traded debt, such as bank debt, which is specified in book value

terms but not market value terms. A simple way to convert book
value debt into market value debt is to treat the entire debt on
the books as one coupon bond, with a coupon set equal to the
interest expenses on all the debt and the maturity set equal to the
face-value weighted average maturity of the debt, and then to
value this coupon bond at the current cost of debt for the
company. Thus, the market value of $1 billion in debt, with
interest expenses of $60 million and a maturity of 6 years, when
the current cost of debt is 7.5% can be estimated as follows:

Estimated Market Value of Debt =

If you want a more precise estimate, you can estimate the
market value of each debt issue separately and adding them all
up at the end.