Question

6. Enterprise Value (EV) was defined in Chapter 2 as EV = Market Capitalization + Debt – Cash. In 6 words, what is another way to calculate EV?

Answer 1

One other method of calculating Enterprise Value (EV)is using DCF method

DCF method is Discounted Cash Flow method. This method is used to analyse an investment or project.

Using DCF method, the EV can be calculated using following steps.

Step 1:

In this step we need to calculate the unlevered free cash flows (UFCF)

UFCF are the free cash flows that are the cash generated by the assets of the business which are available to distribute among the stakeholders.

Step 2:

In this step we need to choose a discount rate.

This rate is most often the WACC= Weighted Average Cost of Capital

Or the required rate of return.

Step 3:

Now, in this step we need to calculate the Terminal Value (TV)

TV is the value of the investment at the end of FCF projection period.

For example, for an investment in machine, it is sold after the useful life of the machine. In this case terminal value is the value obtained from sale of the machine.

Step 4:

This is the final step.

Now, the UFCFs obtained in step 1 and TV obtained in step 3 are discounted using the discount rate obtained in step 2 to obtain the present Values of all the cash flows

Now the Net Present Value is calculated

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

This NPV value is our Enterprise Value (EV).