Multiplier Models: Enterprise Value Model | CFA Level I Equity Investments

Enterprise Value Multiples: An Alternative to Price Multiples

In this section, we’ll explore enterprise value multiples, an alternative to price multiples, which is often viewed as the cost to acquire a company.

Calculating Enterprise Value

To calculate the enterprise value, you need to consider:

• Market value of common and preferred stock
• Market value of debt
• Cash and short-term investments on the company’s books

Enterprise value is the total market value of common and preferred stock, plus the market value of debt, minus any cash and short-term investments.

Since enterprise value takes into account both equity and debt, it is an appropriate measure when comparing firms with significantly different capital structures. One potential problem, though, is that the market value of a firm’s debt is often not available. In such cases, the analyst can use market values of similar bonds or their book values.

Enterprise Value Multiple

An enterprise value multiple has the enterprise value as the numerator, and the denominator can be revenue or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). EBITDA is a proxy for operating cash flow, as it excludes depreciation and amortization.

Because the numerator represents both equity and debt values, it should be compared to earnings available to both shareholders and creditors. EBITDA is usually positive even when net income or cash flow is negative, making it a meaningful multiple.

However, EBITDA often includes non-cash revenues and expenses, which may not represent the cash available for both debt and equity holders.