Question

Russell's has annual revenue of $387,000 with costs of $216,400. Depreciation is $48,900 and the tax rate is 21 percent. The firm has debt outstanding with a market value of $182,000 along with 9,500 shares of stock that is selling at $67 a share. The firm has $48,000 of cash of which $29,500 is needed to run the business.

A: What is the firm's EV/EBITDA ratio?

B: If “comparable” firm or “median industry” EV/EBIDTA is 6.23, is this company undervalued or overvalued? Put it differently, would you buy this company shares or not? Explain in one-two sentences.

Answer 1

(a)

Calculation of EV/EBITDA:

EBITDA = Earnings before depreciation, interest and taxes

= Revenue-Cost

= $387000-$216400

= $170600

EV (Enterprises Value) = Common stock + Debt – Total Cash

Total Cash means most liquid assets in the business

EV = 9500*$67+$182000+$29500

= $848000

EV/EBITDA = $848000/$170600

= 4.97

(b)

Just like Price Earnings ratio, the lower EV/EBITDA, the cheaper the valuation.

If Comparable firm has EV/EBITDA of 6.23, since the Russell’s EV/EBITDA is lower than that of comparable firm, therefore Russell is undervalued.

Investors look for companies that have low valuation using EV/EBITDA, therefore I would like to buy the shares of Russell.