#### Subject 5. Enterprise Value

Since EBITDA are distributed between all types of investors in a company (common shareholders, preferred shareholders, and creditors), they reflect the fundamental value of the company as a whole. Therefore, a multiple using total company value is logically most appropriate. The EV/EBITDA ratio responds to this need.

Enterprise value (EV) is total company value minus the value of cash and investments.

EV = MV of common stock + MV of preferred stock + MV of debt - cash and investments

EV/EBITDA is an indication of company value, not equity value.

Example

• Net income: 34.0
• Interest expense: 7.62
• Cash outflow for interest payments: 4.0
• Depreciation and amortization: 17.2
• Marginal tax rate: 25%
• Cash and marketable securities: 8.9
• Investments: 6.2
• Price per common share on the Paris Stock Exchange: 13.8
• Total number of shares issued: 20,000,000
• Total number of shares in treasury stock: 1,320,000

The company's financial statements show that the only interest-paying liability assumed by the company is a 5-year \$200MM note maturing in 3 years' time and currently trading at 4.13%. The note is paying semi-annual coupons and all interest payments have been met so far.

The company also has preferred stock that is not trading on any exchange. The book value of the preferred stock is \$45. No preferred dividends are currently in arrears.

Solution:

1. Calculation of EBITDA

EBITDA = Net Income + Interest Expense + Depreciation and Amortization + Tax Expense
Tax Expense = (Net Income / (1 - Tax Rate)) - Net Income = [34.0 / (1 - 0.25)] - 34.0 = 11.3
EBITDA = 34.0 + 7.62 + 17.2 + 11.3 = 70.12

2. Calculation of Enterprise Value (EV)

Total market value of common stock = price per share of common stock x number of shares outstanding = Price per share x (shares issued - treasury stock) = 13.8 x (20,000,000 - 1,320,000) = 257.7 MM

Since the company's preferred stock is not publicly traded, we will use its book value for calculation of EV.

Semi-annual coupon on the bond = Cash outflow for interest payments / 2 = 4 / 2 = 2

We know:
the bond's term to maturity = 3 years
Yield to maturity = 4.13%
Semi-annual coupon payments = 2MM
Face Value = 200MM

Therefore, we can calculate the bond's total current market value = \$188.1.

EV = Total market value of common stock + Total market value of preferred stock + Total market value of debt - Cash balances - Investments = 257.7 + 45.0 + 188.1 - 8.9 - 6.2 = 475.7.

3. Calculation of EV/EBITDA ratio

EV/EBITDA = 475.7 / 70.12 = 6.78

• EBITDA is more often positive than net income.
• By adding back depreciation and amortization, EBITDA does not vary according to the depreciation method used. The EV/EBITDA ratio is often used for valuation of capital-intensive companies.
• It is more appropriate than P/E for comparing companies with different financial leverage, since EBITDA is not influenced by interest expenses.