5. What is Enterprise value?

It´s the price that a company would be willing to pay for taking over the company. There are two ways to calculate it. The first one is add up all the assets line by line, but that is a quite hard work. Why not look at how the assets are been paid for, since that´s what the enterprise value does. Are been paid for a shareholder, an bank lending money? Actually a quick way to value a firm is to evaluate where the funds come in rather than count all the assets which are been used or bought.

For example think that you ask me how much did I spend for the Christmas holydays? There are two ways to know it, the first one list all my "gifts" that I bought, but If I bought a lot of things that´s going to be pretty boring. Or just take the ticket from the ATM when I took money to pay the gifts and deduct the amount by my actual cash.

So that what enterprise value does. It says that we should calculate the value of a company looking at how has been paid for, in terms of assets listed one by one. Using for example Tesco, who pays for the assets of  a business like Tesco? The answer is shareholders or banks, Tesco also makes its own profits. What we are going to do is looking at the market capitalization (number of share times the share price). Then we have to add the contribution of banks lenders which is called, net debt(Short term debt-cash)

The logic here is if I ask you how is your house paid for, and you told me that your house worth $200k but I ask you "yes but how is it financed" and your answer is "well, actually with a loan, mortgage, and that´s also $200k" So I´d say that your debt is $200k. But you say " yes but I have $10k in a saving account. So in that case I´d say that your net debt is $200k-$10k= $190$. 

That´s what Tesco does, companies have cash in their balance sheet that they need to pay supplies and so on.So finally using some numbers if the market capitalization was  33.537 million , and the net debt is 9.140, that means the enterprise value for Tesco is the market cap plus its net debt. 42.677.

What does it mean? This would be the price if someone wants to buy out all of Tesco at its market value, but this ratio is also useful to use it with a ratio called EV/ EBITDA.