What happens to enterprise value when a company holds significant cash reserves?

• A. The enterprise value increases
• B. The enterprise value remains unchanged
• C. The enterprise value can become negative
• D. The enterprise value is halved

Answer: (C)

When evaluating how enterprise value is affected by significant cash reserves, understanding the calculation of enterprise value is crucial. Enterprise value is generally calculated as the market capitalization of a company plus total debt, minus cash and cash equivalents.

When a company holds significant cash reserves, this cash is subtracted from the enterprise value calculation. If a company's cash reserves exceed its total debt, this could potentially lead to a situation where the calculated enterprise value is negative. This occurs because the considerable cash balance offsets the total enterprise value, which in certain evaluations can create situations where the enterprise value appears negative if the cash exceeds the combined market cap and debt.

Thus, if cash reserves are substantial enough, it is possible for enterprise value to become negative, illustrating how cash directly impacts this valuation metric.