Why is cash subtracted when computing Enterprise Value?

Why is cash subtracted when computing Enterprise Value?

• A. Because cash is a non-operating asset and Equity Value implicitly accounts for it.
• B. Because cash increases EV by default.
• C. Because cash is a debtor asset.
• D. Because cash is always excess cash.

Answer: (B)

Cash is subtracted when computing Enterprise Value because EV measures the value of a company’s operating assets and the total financing needed to acquire those assets. Cash is a non-operating asset sitting on the balance sheet; when you buy the business, that cash comes along and can be used to pay down debt or be returned to you as the buyer. So, the net cost to acquire the operating business is lower by the amount of cash. In the EV formula, you start from equity value, add debt, and subtract cash to reflect that the buyer would receive or utilize that cash, focusing EV on the value of the core operations rather than liquidity.

Cash is subtracted when computing Enterprise Value because EV measures the value of a company’s operating assets and the total financing needed to acquire those assets. Cash is a non-operating asset sitting on the balance sheet; when you buy the business, that cash comes along and can be used to pay down debt or be returned to you as the buyer. So, the net cost to acquire the operating business is lower by the amount of cash. In the EV formula, you start from equity value, add debt, and subtract cash to reflect that the buyer would receive or utilize that cash, focusing EV on the value of the core operations rather than liquidity.