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Chapter 16
Question 1
This is not an appropriate approach, as DiversCo should be valued using a sum-of-the-parts methodology. One should create a comparable group of firms
operating in the retail apparel sector and another comparable group operating in the energy sector. Multiples should then be constructed for each peer group
and applied to the appropriate division profits for DiversCo.
Chapter 16
Question 2
A forward-looking multiple is a multiple that uses projected earnings or revenues in the denominator. Forward-looking multiples are preferable to backward-looking
multiples for three reasons. First, the latter may include extraordinary items. Second, the former aligns better with the numerator in that they both are based on future values.
Finally, there is less variance in peer-group multiples for forward-looking than for backward-looking multiples.
Chapter 16
Questions 3 and 4
$ million Company 1 Company 2 Company 3
Share price, $ 25 16 30
Shares outstanding, millions 5 8 15
Equity value 125 128 450
Short-term debt 25 15 30
Long-term debt 50 70 40
Total debt 75 85 70
Gross enterprise value 200 213 520
Nonconsolidated subsidiaries – – (50)
Core operating value1200 213 470
EBITDA will be lower for Company 1 if the company outsources
Operating income production. This causes its enterprise-value-to-EBITDA
EBITDA 25 30 59 multiple to be higher than the EV-to-EBITDA multiples of
EBITA 22 23 51 competitors that produce internally.
Multiples, times
Enterprise value to EBITDA 8.0 7.1 8.0 Ignoring the impact of nonconsolidated subsidiaries in the numerator
Enterprise value to EBITA 9.1 9.3 9.2 would overstate both ratios, with the EV/EBITDA being 8.8 and the
EV/EBITA being 10.2. We want to exclude these nonoperating assets
1Also known as net enterprise value. because EBITDA and EBITA are both focused on profits from operations.
Chapter 16
Questions 5 and 6
Driver, $ million Company A Company B Company C Other input
Operating profit 160 160 160 Tax rate, % 25%
Operating taxes 40 40 40
NOPLAT 120 120 120
Growth, % 2% 6% 5%
ROIC, % 15% 10% 12%
WACC, % 10% 10% 10%
Value 1,300 1,200 1,400
EV-to-EBITA multiple, times 8.1 7.5 8.8
Question 5: Company A versus Company B
Company B has an ROIC equal to its cost of capital, so growth fails to create value. Consequently, no premium
is paid for growth, and the company trades at a lower multiple.
Question 6: Company A versus Company C
Both Company A and Company C have ROIC above their cost of capital, so growth leads to higher value. Company C
also has a lower ROIC, but this is more than offset by the higher growth rate.
Chapter 16
Question 7
If future cash flows (and the cost of capital) are the same for two companies, their valuations will be the same. If one
company has lower short-term earnings, as RedBev does, then its enterprise value to EBITA will be higher, since value
remains the same but earnings drop. This can make multiples analysis confusing. A higher multiple doesn't always
mean better long-term prospects. It could just represent a short-term depression in earnings.
Chapter 16
Question 8
All
Income statement, $ million equity Levered Other inputs, %
Operating profit 80 80 Interest rate 5%
Interest expense – (20) Tax rate 25%
Earnings before taxes 80 60
Taxes (20) (15)
Net income 60 45
Enterprise value, $ million
Debt – 400
Market value of equity 900 500
Enterprise value 900 900
Price to earnings, times 15.0 11.1
It is difficult to tell a priori whether a P/E will go up or down with increasing leverage. The calculations here show a decrease in P/E with leverage.
However, this is not always the case. In general, for low- (high-) multiple firms, using debt lowers (raises) the P/E. However, the cost of debt
is also a factor. A takeaway then is that it may be hard to distinguish why one firm has a higher P/E than another firm.
Is it due to operating performance or leverage?
Chapter 16
Question 9
Enterprise-value-to-revenues multiples may mask differences in cost structures between firms. If Firm Y and Firm Z have the same
enterprise-value-to-revenues multiple and the same amount of invested capital, but Firm Z has better operating-profit margins
going forward, then Firm Z should be worth more. This would not show up in the enterprise-value-to-revenues multiple.
Enterprise-value-to-revenues multiples are useful when profits are negative and/or when a firm's current operating profits are
different from long-term expected profits.
Exhibit 16.12 Multiples Analysis: Market and Profit Data
$ million
Company 1 Company 2 Company 3
Market data
Share pricet, $ 25 16 30
Shares outstandingt, millions 5 8 15
Short-term debtt25 15 30
Long-term debtt50 70 40
Operating profit
EBITDAt+1 25 30 59
EBITAt+1 22 23 51
