When calculating enterprise value, which value of equity should be used?

• A. Book value of equity
• B. Market value of equity
• C. Equity value does not factor into enterprise value
• D. Average of book and market value

Answer: (B)

The market value of equity is the appropriate figure to use when calculating enterprise value because it reflects the current market perceptions of a company's worth as determined by the trading price of its shares. This value indicates how much investors are willing to pay for a company's equity at a given point in time, which is crucial for assessing a company's financial health in the context of mergers and acquisitions, investment analysis, and financial modeling.

Using the market value allows for a more accurate picture of the company's valuation as it considers the supply and demand dynamics and future growth potential as perceived by the market. This is essential for stakeholders making investment decisions, as market conditions can significantly impact equity valuations.

Other approaches, such as the book value of equity, reflect the historical cost and may not provide an accurate representation of a company's real-time worth. The average of book and market values may obscure the current market sentiment, and disregarding equity value entirely does not contribute to an accurate enterprise value calculation, which encompasses total firm value by including debt and excluding cash. Thus, opting for market value ensures a realistic assessment of a company’s valuation.