EV and EV/EBITDA

EV is a more appropriate measure to calculate the value of a firm than mere market capitalization from the acquirer’s point of view.

EV= Market capitalization + Debt at market value+ Minority interest at market value+ Preferred equity at market value- cash and cash equivalents

It includes the cost of debt which the acquirer will ultimately have to pay out.

EV/EBIDTA metric is used measure the number of years it would take to payback the investment.

Advantages of this metric:

It is useful for transactional comparisons because it ignores the distorting effect of the individual countries’ taxation policies
It takes into account the debt of the acquired company, hence a better metric. Hence a low value of this ratio indicates a better candidate for takeover.
It is unaffected by the capital structure of the company. For example, if a company issues shares and uses the money to pay off its debt. Its EPS will fall and PE will be higher (i.e. shares will look more expensive). But the EV/EBITDA will remain unchanged.
It remains unaffected by the depreciation and amortization, which are non-cash items.


Note: Generally this ratio is higher for high growth industries and low for low growth industries.