why doesn t market capitalization properly represent a firm s value it leaves a lot of essential factors out such as a company s debt and cash reserves 
enterprise value is a modification of market cap as it incorporates debt and cash for determining a company s value here s an example imagine two identical widget manufacturers company a and company b have the same stock price of 4 32 per share each has 1 million outstanding shares with a market cap of 4 32 million now imagine company a has 500 000 in cash and cash equivalents and 250 000 in total debt its ev total worth is 4 320 000 250 000 500 000 4 07 million company b has 1 million in cash and 250 000 in debt its ev is 4 320 000 250 000 1 000 000 3 57 million the companies looked identical using market cap but a much different picture appears when ev is calculated enterprise value vs p e ratiothe price to earnings ratio p e ratio is the ratio for valuing a company that measures its current share price relative to its earnings per share eps the price to earnings ratio is sometimes known as the price multiple or the earnings multiple the p e ratio doesn t consider the amount of debt that a company has on its balance sheet ev includes debt when valuing a company and is often used in tandem with the p e ratio to achieve a comprehensive valuation limitations of evas stated earlier ev includes total debt but it s essential to consider how the company s management utilizes the debt for example capital intensive industries such as the oil and gas industry typically carry significant amounts of debt which is used to foster growth the debt could have been used to purchase a plant and equipment as a result the ev can be skewed when comparing companies across industries this is essential to consider if the company being looked at is undergoing a merger or acquisition this is because the acquiring company will need to account for the amount of debt it is taking on in the merger investors can use this information to evaluate what the merged companies will look like in the future as with any financial metric it s best to compare companies within the same industry to better understand how the company is valued relative to its peers example of evas stated earlier the formula for ev is essentially the sum of the market value of equity market capitalization and the market value of a company s debt less any cash a company s market capitalization is calculated by multiplying the share price by the number of outstanding shares the net debt is the market value of debt minus cash a company acquiring another company keeps the cash of the target firm which is why cash needs to be deducted from the firm s price as represented by the market cap let s calculate the enterprise value for macy s m for its 2021 fiscal year macy s recorded the following 2we can calculate macy s market cap from the information above macy s has 292 4 million outstanding shares valued at 25 44 per share at the end of its fiscal year jan 29 2022 32enterprise value is considered comprehensive when valuing a company because if a company were to purchase macy s outstanding shares for 7 44 billion it would also have to settle macy s 3 30 billion in outstanding debts in total the acquiring company will spend more than 10 billion to purchase macy s however since macy s has 1 71 billion in cash this amount could be added to repay the debt 