CFA CFA Level 1 EV/EBITDA clarification

EV/EBITDA clarification

  • This topic has 3 replies, 2 voices, and was last updated Apr-17 by vincentt.
  • Author
    Posts
    • lulu123
      Participant
      Up
      0
      Down

      Which of the following multiples is most useful when comparing companies with significant differences in capital structure?
      A. EV/EBITDA
      B. Price-to-book ratio
      C. Price-to-cash flow ratio

      A is correct. The EV/EBITDA approach is most useful when comparing companies with significant differences in capital structure. EBITDA is computed prior to payment to any of the company’s financial stakeholders and is not impacted by the amount of debt leverage.

      I thought that the answer is C.
      I did not pick A because EV has market value of debt in it so I thought that if they have large different in capital structure –> large differences in proportion of debt –> so not use EV/EBITDA……..

      can anybody explain the answer to me please?

    • vincentt
      Participant
      Up
      5
      Down

      EV consists of more than just market value of debt. It also includes things like MV of common stocks, MV of preferred stocks and any other debts so basically it covers equity and debt.

    • lulu123
      Participant
      Up
      2
      Down

      @vincentt
      yes I know but that’s exactly my point: if the structures are very different, then why would you want to use the EV ratio?…. or should I be thinking the exact opposite: since it has all that, its a GOOD comparison base?

    • vincentt
      Participant
      Up
      3
      Down

      For example,
      Company A
      current price: $20
      book value (which is equity): $5 per share

      Company B
      current price: $20
      book value: $10 per share

      Company A would have a P/B ratio of 4x while company B would have a P/B ratio of 2x.

      That’s due to their differences in capital structure. So valuation multiples that doesn’t specifically use equity or debt values would be the best to evaluate companies that very different capital structure.

      Hope that make sense.

Viewing 3 reply threads
  • You must be logged in to reply to this topic.