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There are multitudes of ways to value a company, as well as specific equity and debt claims on a company’s assets. One is the EBITDA valuation method, which relies on a multiple of EBITDA to arrive at a company’s enterprise value.
The definition of enterprise value is the total value of a firm’s equity and debt. It can also be thought of as the total market value of a company’s expected cash flow stream. A company’s EBITDA is a measure of that stream. Furthermore, EBITDA is a company’s net income with tax, interest, depreciation, and amortization expenses added back. It is not an exact measure of a company’s cash flow, but it is one which has gained wide acceptance in the banking and investment communities.
Use the following enterprise valuation formula:
Base the multiple on comparable actual sales transactions occurred recently in the company’s industry. Often, one will use the derived multiples of publicly traded companies in the industry in addition to or in lieu of actual transactions.
Also, while you may use a single value for the EBITDA multiple, you often get a range. This range is based on the distribution of comparable multiples, with abnormally high or low multiples excluded so as to provide a useful range for the end user of the valuation.
Use the EBITDA valuation method to value a company’s total equity. After arriving at the company’s enterprise value using the formula described above, subtract the net debt of a company to determine the value of the equity claim on the firm’s total cash flow. Methods used to directly value equity adjust the firm’s cash flow to yield the cash flow available to shareholders. This is also known as “Free Cash Flow to Equity.”
The primary problem is that this method relies on EBITDA as a measure of a firm’s cash flow, ignoring other significant factors which can impact a company’s cash flow, such as changes in working capital and capital expenditures. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.
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