Below is an excerpt from Fasttrack Ltd’s Financial statement. The EV/ EBITDA multiple of the company is closest to $ mn Shareholder Equity 1,250 Long term Debt 800 Short term Debt 300 Cash 120 EBITDA 735 Total Market Cap 2,125 a. 3.03X b. 4.22X c. 4.55X Ans B: EV = Market Cap + value of debt – cash = 3105. EV/EBITDA= 3105/735 Shouldn’t the answer be C? Asset+Debt-Cash, which is (1100+1250)+(1100)-120 = 3230/735 = 4.55x
Enterprise Value formula = Market Capitalization + value of debt - (cash + marketable securities).
It seems the shareholder equity part is included to try and mess people up. Shareholder equity is a snapshot in time found on the balance sheet and since market cap or the value of the equity fluctuates everyday, the market cap better captures the cost to buy a company and would be used instead of shareholder equity.
So, it is market value of assets- cash and marketable securities? What about the debt? If you want to buy a company, you have to pay for all the assets they have (except the most liquid ones i.e. cash and cash equivalents). Don’t you have to pay for the liabilities also? At some point of time, you have to pay the liabilities off. So, it should be market value of assets +value of debt. What am I missing here?
Going by the basic accounting equation of A = L + E, you could say that market value of assets would be equal to market cap + debt. That might confuse though later on.
Think of it this way, in order to buyout a firm a prospective buyer would need to pay for all claims on the company. All claims on the company are typically exchanged for capital. Capital is made up of equity, debt and preferred stock. In the problem you listed, no preferred stock is mentioned so it makes it easier. The liabilities are not added because they are a part of the operating cycle and barring extreme situations i.e. where a company has significant cash flow or a/p problems, the cash that would be generated by the operations of the business would be able to service all current liabilities to a sufficient extent.
Your equation in your original post that got you to 4.55x is because you added debt twice. Once in the assets and again when adding debt. You also used book value of equity (A-L) = E not the market cap which is what the equity is worth to investors who hold shares (residual claims).
For the exam, just remember to add Market capitalization (shares outstanding x share price) not the book value of equity if given + debt - (cash + marketable securities) to figure out EV. If you find yourself in I banking you may have to modify this equation on a case by case basis. Hope this helps : )