EV / EBITDA

CFA Level II
#1

Hello, could someone please confirm if my understanding is correct regarding the below:

  1. Is it correct to say that Firm Value which is FCFF(1+g) / (WACC - g) is the same exact thing as Enterprise Value which is the Market Value of all invested capital (equity, preferred stock, debt) less cash, cash equivalents and short term investments. I get the idea that they are the same thing, but the textbook makes no specific mention to their equivalence.

  2. To justify an EV / EBITDA multiple, the text mentions that the fundamentals drivers of this ratio are WACC, expected sustainable growth in FCFF, and ROIC. It doesnt show the derivation but I asumme it is based on the Firm Value formula: FCFF (1+g) / (WACC - g). Assuming firm value and enterprise value are the same concept, we can divide bother sides by EBITDA to get an expression for EV / EBITDA.

EV / EBITDA = (FCFF / EBITDA)(1+g) / (WACC - g). I am not sure of the role played by ROIC in this foumula, I assume it has something to do with the ratio of FCFF / EBITDA, which is the portion of pre-interest earnings that is availble for distribution to all providers of capital. If ROIC increases, then the portion of ROIC that is FCFF increases which increases EV / EBITDA.

Could someone please comment. Thanks in advance.

1 Like
#2

No one knows?

#3

1.) They are the same thing to the extent that the working capital requirement reflected in your Free cash flows exclude cash. If cash is included in working capital, you get MVIC (not EV), bc this implies that cash is being captured in the cash flows; if cash is included, it can’t be EV. There are two indications of firm value: MVIC and EV (MVIC less cash). They both indicate firm value. One is with and the other is without cash. The reason the distinction is made is becuase an acquirer will often not pay for the cash, you’re essentially just swapping cash. If a company’s operating value is worth $95mm and it has $5mm in excess cash on the balance sheet, the total company value is $100mm. A buyer could pay $100mm, and keep the excess cash to with what he pleases. Or, he could pay $95mm and let the buyer take the excess cash. EV is the latter case bc why would you pay cash to buy cash. At the end of the day though, it’s six one way, half dozen the other. Doesn’t matter, you’re paying and receiving the same thing at the end of the day.

2.) Bro, you’re way overcooking with the second question. No need to go through that mental exercise. By all means, if it works for you (thinking through it like that), then go with it. But if the text didn’t bother to show, let alone describe, in depth the derivation (as it did for the others), then I wouldn’t waste my time.

Nevertheless, just know that they all boil down to growth and risk for the most part. Profitability/return is also key to understanding multiples. ROIC, the way you’re thinking about it, would be reflected in the FCFF. Your FCFF would reflect the return your operations are generating. But again, while I applaud your appetite for thought, I say you’ve got it, keep going.

#4

Thanks alot Miller.

#5

sorry please see latest post below.

#6

2014 March Version B Mock Afternoon Paper

[question and answer removed by admin]

Can I check why & when do we need to add Cash & S-T investments in this case to derive equity value?

There is a question earlier in the same mock paper (Zenith ThermoPlastics) qn 2 where the valuation of firm is derived using projected FCFF, which thus equals to EV, but no cash is added to derive equity value.

#7

for question 2 : You are right that the derivation starts with the FCFF next year/ (cost of capital -g) .

I think derivation is not that important here but in case you want to know where ROIC came, here you have some pointers:

  1. FCFF = EBIT(1-T)(1-reinvestment rate) where reinvestment is in the form of net capex and change in non cash working capital

reinvestment rate = g/return on capital

Hence when you substiture these in your formula, you will see how it depends on WACC, g and ROIC

hope that helps

#8

saurabhm , thanks alot. my purpose of stating FCFF discounted at WACC should give EV, yet the answer did not entail adding cash to derive the equity value after deducting for debt. On the other hand, other qn within the same paper highlights that once we have the value of EV, we should add cash, before deducting debt to derive the equity value. So, when should we add cash…

#9

Hi I checked Q2 of 2014 afternoon paper ( Zenith). The FCFF is 121 which is straightforward

Can you suggest which other question you are talking about? I can check that

Thanks

#10

Hi, Qn 3.

where it is not necessary to deduct cash in deriving equity

Terminal value at start of 2013 3,723/(1.105)4 2,497 Enterprise value 3,050 Less debt after acquisition 650 Maximum value of equity 2,400 Maximum price per share (60 million shares) 2,400/60 = $40

#11

I just checked.

I did not look at the solution and worked out the problem and got the answer.

The issue it seems is that curriculum is using EV and value of firm interchangeably

The value of the firm here is simply the present value of FCFF ( which curriculum writes as EV which would be true if the company does not have any cash), you reduce the debt and that gives you the equity.

In the Exam if I get similar kind of problems with FCFF, the PV of FCFF will give me the value of the firm and I wouldnt care about the cash, I will simply deduct debt to get market value of equity

#12

Here debt = accounts payable + notes payable + long term debt? I did a question on FCFF and had to deduct above 3 to arrive at firm equity

#13

accounts payable is not considered as debt obligation

short term portion of long term debt

notes payable

long term debt (issued bond or bank loan)

#14

But here CFAI had deducted AP also

#15

Equity = FCFF firm value -all Liabilities

#16

Sorry I mean on EV calculation regarding the title of topic

and market value of debt. Value of firm equity is FCFF - all debt (derived from A - L).

#17

Thanks. Agreed on the FCFF portion.

On the other hand, if EV is provided, to deduct cash, and debt to obtain equity value.