Question

I am given the following problem and solution. When comparing the net sales ratios, what does this indicate about the firms? If they were to drop below 1, what would this mean?

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

1.EV/sales is a quantifiable metric of how much it costs to purchase a company's sales

2. It can be used for the companies which do not generate profits

.

A lower EV/sales multiple means that a company is more attractive or undervalued.

EV/sales below 1 indicate that sales of the company are more than the enterprise value, reason for such a low valuation may be because company might in the initial phase and burning lot of cash (ie incurring huge losses)

Since there are huge losses value of equity is low, therefore enterprise value is low

since EV is out numerator in the formulae of EV/Sales

therefore it can go below 1 levels