Question

I am given the following problem and solution. Can someone explain what the EBITDA ration indicate when comparing the firms? What is considered a "good" EBITDA ratio?

1. [Relative Value Concepts Using Multiples] The WestTek privately held venture is considering the sale of the venture to an outside buyer. WestTek has net sales = $21.2 million, EBITDA = $11.1 million, net income = $2.9 million, and interest-bearing debt = $12 million. Three publicly-traded comparable firms or competitors in the industry have the following net sales, EBITDA, net income, equity value or market capitalization (stock price times number of shares of common stock outstanding), and interest-bearing debt information:

       

EastTek SouthTek NorthTek
Net sales $25,000,000 $37,500,000 $80,000,000
EBITDA 12,500,000 20,000,000 37,500,000
Net Income 2,500,000 3,000,000 10,000,000
Equity Value 45,000,000 60,000,000 160,000,000
Interest-bearing 15,000,000 20,000,000 40,000,000

A. Calculate the enterprise value to net sales ratios for each of the three competitors (EastTek, SouthTek, and NorthTek), as well as the average ratio for the competitors.

     

      Enterprise value = equity value + interest-bearing debt

      Equity value = market capitalization (i.e., stock price times shares outstanding)

      EastTek: ($45,000,000 + $15,000,000)/$25,000,000 = 2.40

      SouthTek: ($60,000,000 + $20,000,000)/$37,500,000 = 2.13

      NorthTek: ($160,000,000 + $40,000,000)/$80,000,000 = 2.50

      Average: (2.40 + 2.13 + 2.50)/3 = 7.03/3 = 2.34

B) Calculate the enterprise value to EBITDA ratios for each of the three competitors, as well as the average ratio for the competitors.

      EastTek: $60,000,000/$12,500,000 = 4.80

      SouthTek: $80,000,000/$20,000,000 = 4.00

      NorthTek: $200,000,000/$37,500,000 = 5.33

      Average: (4.80 + 4.00 + 5.33)/3 = 14.13/3 = 4.71

Answer 1

In this case the EBITDA ratio is given as Enterprise value to EBITDA. This ratio compares enterprise value of each firm with its earnings before interest, tax, depreciation and amortization. This ratio is used by firms to value their business. This ratio compares the total value of firm that is debt plus equity to the cash earnings generated by company.

EBITDA ratio indicates better valuation of company than price-earnings ratio.

A lower EBITDA ratio indicate that stock is undervalued and higher EBITDA ratio indicates that stock is over valued or over priced. This mean the lower EBITDA ratio makes the stock more attractive. Preferably EV.EBITDA ratio of less than 10 is considered as healthy.