February 13, 2012 By Prem

EV/EBITDA is a valuation multiple used to measure the value of a company. This important multiple is often used in conjunction with, or as an alternative to, the Price/Earnings ratio to determine the fair market value of a company. Enterprise value or EV is the cost of buying the right to the whole of an enterprises core cash flow. It is equal to the estimated value of the operations of an enterprise as represented by the value of the various claims on cash flow and profit.

EV equals market capitalization plus seasonally adjusted net debt, pension provisions, the value of minorities and other provisions deemed debt.

How to calculate EBITDA?

In order to calculate EBITDA, start with earnings from continuing operations excluding the non-recurring items and to that earning numbers, add interest, taxes, depreciation and amortization.

How to calculate Enterprise Value?

Calculation of enterprise value can be done as follows:

Enterprise Value = Market value of common equity + Market value of preferred stock + Market value of debt cash and investments.

Market value of common equity can be calculated by multiplying the price of share with number of shares outstanding.

Cash and investments are also known as non-earning assets and they should be subtracted because EV measures the price an acquirer would pay for entire company. The cash and investments lowers the cost of net acquisition, so it is kept out. Similarly, in repurchasing the debt, the acquirer has to pay the market value, and if the market value is not available, than the book value as stated in balance sheet can be used.

Let us understand this with an example:

Suppose a company has three type of common equity shares viz Special Class A, Class A and Class B shares. Closing share prices of special Class A shares (non voting) is $45.875 and $45.25 for Class A shares (one vote per share). Class B shares (15 votes per share) is not trading in stock market. Outstanding shares of special Class A shares is 908.015192 million shares, Class A is 21.83225 million shares and value of Class B as per books is 9.4 million.

Preferred stock as per books is 59.5 million. Long term debt as per books is 10, 517.4 million and the minority interest and others is equal to 1257.2 million.

The asset side of the balance sheet states the following items (in millions):

Cash and cash equivalents $651.5

Investments $3,059.7

The income statement states the following items (in millions):

Net income $2,021.5

Net income for common stockholders $1,998.0

Interest expense $691.4

Taxes $1,441.3

Depreciation $837.3

Amortization $1,794.0

We first calculate EBITDA.

We always select net income (which is net income available to both preferred and common equity) in the EBITDA calculation:

Net income $2,021.5 + Interest $691.4 + Taxes $1,441.3 + Depreciation $837.3 + Amortization $1,794.0 = EBITDA $6,785.5

Than We calculate the value of all equity, adding to it minority interest and other.

Special Class A issue ($45.875 × 908.015192 million shares) 41,655.20

Plus: Class A issue ($45.25 × 21.83225 million shares) 987.91

Plus: Class B stock (per books) 9.4

Equal to: Common equity value 42,652.51

Plus: Preferred equity (per books) 59.5

Equal to: Total equity 42,712.01

Plus: Minority interest and other 1,257.2

Equal to: Common equity plus minority interest 43,969.21

The sum of cash and cash equivalents plus investments is $651.5 million +$3,059.7 million = $3,711.2 million.

So, EV=$43,969.21 million + $10,517.4 million − $3, 711.2 million = $50, 775.41 million.

We conclude that EV/EBITDA = ($50, 775.41 million) / ($6,785.5 million) = 7.5.

How to use EV/EBITDA as comparables?