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Introduction
The Enterprise Value to EBITDA ratio, also known as the EBITDA multiple, is a ratio used to measure the value of a company. Usually, the reason for calculating the EV/EBITDA ratio is to use it as a comparison tool between different companies. It can also be helpful in other techniques, such as Comparable Company Analysis. The multiple has two components, Enterprise Value and EBITDA.
Enterprise Value (EV) is a measure of the total value of a company. EV is the sum of the current market capitalization of a company, its debt, minority interest, and preferred shares, less its cash and cash equivalents. On the other hand, EBITDA represents the earnings of a company before considering its interest, taxes, depreciation, and amortization.
Uses of Enterprise Value to EBITDA Multiple
As mentioned above, the EV/EBITDA multiple can help in comparing the value of different companies. This ratio can help investors determine how many times the EBITDA of a company they have to pay if they want to acquire the company. It can also help in the calculation of the terminal value in the Discounted Cash Flow (DCF) model. Finally, it can also help in calculating a target price for a company in an equity research report.
Advantages of Enterprise Value to EBITDA Multiple
There are many advantages of using EV/EBITDA multiple. First of all, it is easy to calculate and the information required to calculate it is readily available. Secondly, as mentioned above, it can help provide a comparison between the values of different companies. Most experts also prefer the EV/EBITDA ratio as compared to other metrics such as the Price to Earnings ratio. Finally, the multiple works great for valuing a well-established business with low capital expenditures.
Disadvantages of Enterprise Value to EBITDA Multiple
The EV/EBITDA multiple may also have some disadvantages. First of all, it does not take into account the assets or capital expenditures of a company. It is also not a good proxy for cash flow due to its use of the EBITDA. It is also hard to adjust for companies with different growth rates. The ratio is also susceptible to manipulation due to its use of EBITDA.
Example
A company has an Enterprise Value of $300 million and an EBITDA of $30 million. It can calculate its EV/EBITDA multiple in the following way.
EV/EBITDA multiple = Enterprise Value / EBITDA
EV/EBITDA multiple = $300 million / $30 million
EV/EBITDA multiple = 10 times
In this example, the EV and EBITDA are already available. However, practically, these figures are not available beforehand and need to be calculated. For instance, if investors want to calculate the multiple, they must obtain the current market capitalization, debt, minority interest, and value of preferred shares of a company. After that, they need to deduct cash and cash equivalents from the sum of those amounts. Similarly, they must add the interest, taxes, depreciation, and amortization of the company to its earnings to obtain its EBITDA.
Conclusion
The EV/EBITDA multiple is a ratio calculated by dividing the Enterprise Value (EV) of a company by its EBITDA. It has different uses, including being used to calculate the value of a company and as a comparison tool. There are many advantages of using the multiple. However, it may have its disadvantages as well.
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