# Accounting: Enterprise Value to EBITDA

Courses | Accounting |

Language | English Language |

### Transcript

you had a home you just bought for two hundred

thousand dollars down with a five hundred thousand our mortgage

the enterprise value of that home would be seven hundred

grand And parenthetically it's equity value would be two hundred

grand and you'd have two hundred grand in equity in

it and five hundred grand in debt on it Businesses

air valued And I'm kind of in a similar way

A company with say a hundred million dollars in even

or cash flow or cash profits might trade it and

say twelve times that even don number for now Don't

worry about why it trades a twelve twenty five at

twelve times that hundred million dollars in cash flow That

company is worth one point two billion dollars Why Because

Wall Street says so But the market capitalization of the

company might be we'll say only seven hundred million Why

Well because it has six hundred million dollars in debt

and one hundred million dollars in cash or net debt

of five hundred million box so that five hundred million

get subtracted from the one point two billion total to

get the equity value or set another way The enterprise

value of that business is one point seven billion because

you'd add that five hundred million dollars to the enterprise

notionally worth twelve times that hundred million bucks in cash

flow to try and replace it Lots of numbers and

ratios were thrown at you here So hang glider loose

or however you want Okay so even even does a

common evaluation metric or ratio in companies that a have

a lot of debt be are depreciating A lot of

capital expenditures and well see often don't have meaningful gap

earnings So another method has to be worked out to

evaluate their self worth other than ours The Friday in

therapy will help in the numbers Let's redo our definition

here of enterprise value from another angle there or even

the same angle there but with different lenses All right

there we go Let's start with a new home The

rich version of you just bought it for a million

dollars putting two hundred grand down and taking out a

mortgage for a hundred thousand bucks The equity or equity

capitalization Our equity value you have in your home at

this point is what now Yes two hundred thousand dollars

and the home's enterprise values a million bucks right We've

just said that because it would take a million bucks

toe fully replace that home Its enterprise value is a

million dollars Yes we're hammering this home Okay now back

to a more detailed company story Let's say human catapulting

has even Dov Forty million and one hundred sixty million

of debt Its growth rate in the industry trend suggested

it should trade about and ten times Even so ten

X EBITDA would give us four hundred million dollars of

gross value for the company But there's a hundred sixty

million dollars of debt which has to be subtracted from

the gross value to get the equities value So we

subtract hundred sixty million from the four hundred million dollars

to get two hundred forty million dollars of equity value

Like if the stock was trading publicly and there were

say ten million shares out it would be trading probably

at about twenty four bucks a share right Because the

stock price shows you what the equity value is The

Wall Street paying for it And we'd say that this

firm with one hundred sixty million dollars of debt is

lev ird for toe one debt Teo even dog that

is one hundred sixty million of debt TTO forty million

of even doc We don't ask ourselves Well how does

this company compare to human slingshots ink and to the

humoring ink as weapons of Miss Destruction Right Well slingshots

traded a lower multiple because while misfires air costly but

Human Rang trades at a premium of twelve times a

bit DA because of the nature of its physics in

the form of reusable humans when the shot is a

mist well this would be the comparable company multiple or

come Paco and in this case human catapults trade and

as might be expected at the midpoint of the range

of comparables aren't the last Metro is discounted cash flow

analysis which is the heavy valuation machinery that the professionals

generally used along with a weighted average cost of capital

In putting mathey clarity around their investment dollars Remember the

mantra A dollar today is worth more than a dollar

tomorrow This is the heart and soul of discounted cash

flow analysis Right So you're going to discount cash flows

into the future for risk and time But let's take

a deeper look A company will produce Net after everything

cash of one hundred dollars in your one two hundred

dollars in year two two fifty and three five hundred

for and eight hundred in Year five When it gets

sold on that eight hundred includes it's selling price so

this would be called shockingly a five year discounted cash

flow analysis Well your next step here is figure out

the discount rates The risk free rate is usually whatever

US government bond paper trades for In the analogous time

period that is you'd find a ten year T bill

that is halfway through its life span and figure out

what the rate is that it's paying If you went

to buy it right now so I'll say it's three

percent that's the five year risk free rate The risk

premium is the extra rate of interest You're going to

account for the likelihood that instead of producing in millions

on hundred two hundred to fifteen above above the company

produces on LY one hundred one hundred one hundred hundred

fifty so the company might do terribly relative to expectations

But it also might do a ton better than you

know your gases or projections The projection should generally be

in the fifty fifty over under his own III the

most likely case like you know when you have an

NFL game and there's a fifty fifty over under for

how many points are scored for both sides you know

stuff like that So let's say the premium on this

set of cash flows is eight percent to produce a

total of eleven percent That is there's eight percent in

risk on top of the risk free rate that attack

on right so total discount rate will be eleven percent

You then just set up the equation such that the

first five years show cash produced And then at the

end of those five years company is sold or goes

public or gets liquid or whatever But you sell all

your shares or all your assets or ownership and you

know you get your terminal value there Your end value

So let's say the company sells for a billion dollars

at the end when the tricky part in this SAT

lies in the power it aeration of the equation And

it would look something like this Yeah you don't need

to do the math here All you have to do

is think Yes we ask a lot Note that the

denominator of one point one one is iterated a ton

more in the out years versus hear one and one

point one one two the fifth powers about one point

seven So yeah interesting In your five you're dividing those

huge numbers by a pretty big number The notional eight

hundred million dollars in profits on a discounted basis is

only around four hundred seventy million Only stuffs what it's

worth today Almost half that is its present value is

just a bit more than half its terminal value The

key notion here is to separate balance sheet shenanigans and

our assets from the future earnings potential of the company

itself It is this separation that usually motivates an enterprise

value to even top perspective or valuation of a company

because in doing so the balance sheet is then separated

into the naughty chair words It's alone where it can

cloud the picture of the actual earnings potential of the

company itself and more pedantic Lee Company with a billion

dollars of net cash on its balance sheet should in

fact have a different lens looking at it like a

green one because it has so much excess cash you

know that it would when compared with a company with

three billion dollars of net debt So bottom line the

balance sheet matters a lot You have to adjust your

ratios to reflect company values because of it and you

know balance sheet matters And when it gets so does 00:07:40.277 --> [endTime] the thickness of the wall That's gotta hurt Hey