EBIT and EBITDA

CFA Level III
#1

Which one is the base to calculate operating profit margin? I think it is EBITDA. But in 2007 CFAI exam Q10, the answer uses EBIT and states depreciation expense is also a variable used to estimate the S&P500 aggregate operating profit margin. I used Schweser for review and do not find any support for depreciation from notes. Schweser states that four factors affecting this margin: labor unit costs, inflation, capacity utilization, and foreign competition.

#2

you should be able to get away with both. as per the question your refering to, stating that depreciation affects operating margin is valid as long as you make it clear you are defining operating margin at EBIT. In the schweser texts they go through their example using EBITDA and state that its the most stable.

#3

Even though in reality when analysts term operating profit they often mean EBITDA, for purposes of CFA operating profit is talking about EBIT not EBITDA

#4

^agreed.

#5

Is this related to anything for L3?

#6

Sort of. When you are computing the estimates EPS for an index. Step 1: Estimate overall sales by regressing GDP on index sales Step 2: Estimate an operating margin % (EBITDA) Step 3: Estimate Depreciation and Amortization Step 4: Estimate Interest Step 5: Estimate Taxes Step 6: [(Sales x EBITDA %) - D&A - Interest] x (1-t) = EPS Then apply appropriate multiple from matrix to arrive at fair value

#7

Does the estimate of D&A come from estimates of capex? And how about interest? is there an assumption of leverage?

#8

I don’t have the book with me. I doubt we have to get that nitty-gritty for the exam. Thoughts?

#9

Without getting into the specifics, there was a question like that on the PM section last year where you had market averages for balance sheet info and had to figure out the fair value of the index or something like that. I thought it was a sneaky way to get FSA into the exam, even though FSA is technically not a L3 issue anymore.

#10

I have NO recollection of this material. Not good.

#11

need to estimate op profit margin to get from Sales to EBITDA. (because historial and recent EBIT and EBITDA are too volatile to use) recommended method is to estimate Op profit margin from 4 variables: capacity utilisation unit labor cost inflation rate level of foreign competition apply this op profit margin to Sales (which is obtained from regression against nominal GDP) to arrive at EBITDA, then deduct depreciation, interest, tax rate = to get EPS nasty stuff - it’s in LOS 24(d) - says “compare and contrast alternative approaches to the estimation of earnings per share” …it is the context of national equity index valuations - so i guess we need to know the different methods…