How is Enterprise Value (EV) calculated?

Enterprise Value (EV) is a measure of a company's total value, often used as a comprehensive alternative to market capitalization. The correct calculation of EV takes into account the market capitalization, preferred stock, debt, and subtracts cash and cash equivalents.

When calculating EV, the goal is to assess the cost of acquiring the entire company. Starting with the market capitalization represents the equity portion of the company's value. Adding preferred stock and debt reflects the total capital structure, acknowledging that these elements represent obligations or claims that need to be paid off in any acquisition scenario.

However, cash and cash equivalents are subtracted because they can be used to pay down debt or as part of the purchase price, effectively reducing the net cost of acquiring the company. This approach provides a clearer picture of what it would truly cost to take over the company, incorporating its financial obligations and liquid assets.

This accurate representation of EV is why the choice that reflects the sum of market cap, preferred stock, and debt, minus cash and cash equivalents, is the correct method for calculating Enterprise Value.