Comments On Basic EV Equation
- All the components particularly relevant in liquidation analysis, since using absolute priority in a bankruptcy all securities senior to the equity have par claims. Generally, also, debt is less liquid than equity so that the "market price" may be significantly different from the price at which an entire debt issue could be purchased in the market. In valuing equities, this approach is more conservative.
- Cash is subtracted because when it is paid out as a dividend after purchase, it reduces the net cost to a potential purchaser. Therefore, the business was only worth the reduced amount to start with. The same effect is accomplished when the cash is used to pay down debt.
- Value of minority interest is added because it reflects the claim on assets consolidated into the firm in question.
- Value of associate companies is subtracted because it reflects the claim on assets consolidated into other firms.
- EV should also include such special components as unfunded pension liabilities, employee stock option, environmental provisions, abandonment provisions, and so on, for they also reflect claims on the company's assets.
- EV can be negative in certain cases—for example, when there is more cash in the company than the value of the other components of EV.
Read more about this topic: Enterprise Value
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