Enterprise Value vs Equity Value

If you wanted to buy a house that still had a mortgage on it, the seller's asking price for their equity in the house isn't what it would cost you to own the house outright — you'd also have to deal with that mortgage, either paying it off or assuming it. Equity value is analogous to the seller's slice; enterprise value is the cost of taking over the whole property, debt included.

The two numbers

Equity value (market capitalization, for a public company) is simply share price times shares outstanding — what it costs to buy every outstanding share.

$$\text{Equity Value} = \text{Share Price} \times \text{Shares Outstanding}.$$

Enterprise value (EV) adjusts equity value to reflect the value of the whole operating business, independent of how it happens to be financed:

$$\text{EV} = \text{Equity Value} + \text{Total Debt} - \text{Cash and Equivalents}.$$

In words: add debt because an acquirer of the whole company would have to take on or repay that debt on top of buying out shareholders; subtract cash because that cash could immediately be used to help pay down the debt, effectively reducing the real net cost of the acquisition.

A worked example

A company trades at $40 a share with 50 million shares outstanding, so equity value is $40 \times 50 = 2{,}000$ (in millions), i.e. $2,000m. It carries $600m of total debt and holds $150m of cash.

$$\text{EV} = 2{,}000 + 600 - 150 = 2{,}450.$$

An acquirer buying every share for $2,000m would also inherit $600m of debt obligations, but could immediately use the $150m of cash on hand toward that debt — so the true economic cost of taking over the whole business is closer to $2,450m, not the $2,000m sticker price on the equity alone.

Why the distinction drives which multiple you use

Valuation multiples must pair a numerator and denominator that represent claims to the same group of investors. EBITDA and EBIT are pre-interest, so they belong to everyone (lenders and shareholders) — pair them with EV: EV/EBITDA, EV/EBIT. Net income and EPS are after interest is paid to lenders, so they belong only to shareholders — pair them with equity value or share price: P/E is price (equity value per share) over earnings (net income per share).

Mixing these — say, comparing EV to net income — implicitly compares a "whole business" number to an "equity holders only" number and produces a multiple that isn't comparable across companies with different amounts of debt.