Equity Investments
coreEnterprise Value & EV/EBITDA
- share price × shares outstanding: the market value of the equity slice
- total borrowings the buyer would assume (market value, ideally)
- cash and equivalents — recovered by the buyer at once, so it reduces the true price
- enterprise value: the all-in cost of buying the whole business
- the takeover price per dollar of pre-financing operating earnings
Reading the notation
Why it must be true
Market cap prices only the shareholders' slice. But if you bought the whole company — the takeover thought-experiment — you would also inherit its debts and pocket its cash. Enterprise value is that all-in takeover price: equity, plus the debt you must service, minus the cash you find in the till on day one.
That is why EV/EBITDA beats P/E for comparing differently-financed firms: both sides of the ratio are capital-structure-neutral. EBITDA is the operating cash stream before any financing claims, EV is the price of all the claims together — so a leveraged firm and a debt-free twin with identical operations score the same multiple, as they should.
The derivation
Price the claims, not the shares. A buyer of the entire business acquires:
Scaling by the pre-financing earnings stream gives the multiple:
Both numerator and denominator sit ABOVE the financing line — that alignment is the whole design.
When to reach for it
Valuing or comparing whole businesses regardless of financing — M&A pricing, or any multiple comparison across firms with different leverage.
Listen for
Back-of-the-envelope
Estimate it in your head first — then the calculator only confirms.
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Net debt first: Debt − Cash in one step, then add market cap. Negative net debt (cash-rich tech firms) makes EV LESS than market cap — not an error.
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Multiple bands: mature industrials trade around 6–10× EBITDA; double digits means growth or froth. A computed 40× on ordinary inputs means a units slip.
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P/E vs EV/EBITDA disagreement is information: a firm cheap on P/E but rich on EV/EBITDA is usually hiding leverage.
Traps in applying it
- ✗Forgetting to subtract cash — the buyer recovers it, so gross debt alone overstates the price.
- ✗Comparing EV to NET income — the denominator must also be pre-financing (EBITDA or EBIT), or the ratio mixes claim levels.
- ✗Using book value of equity instead of market cap in the sum.
Limits & criticisms
EBITDA is a rough cash proxy that ignores capital expenditure entirely — Buffett's jibe ("does management think the tooth fairy pays for capex?") lands hardest on asset-heavy firms where depreciation is a real, recurring cost. EV itself hides off-balance-sheet items (leases, pensions, minority interests) that a real buyer would count, and market-value debt is often quietly proxied by book.
Where it came from
EV multiples came out of the 1980s leveraged-buyout wave: raiders comparing takeover targets needed a price that included the debt they'd assume, and a cash-flow proxy (EBITDA, popularized by John Malone at TCI to flatter his levered cable empire) that ignored how the last owner financed it. Today EV/EBITDA is the default multiple of M&A banking, private equity screens and credit analysis — quoted as casually as P/E, and preferred whenever capital structures differ.
One identity, 2 questions
The exam can hide any variable. Each face below is the same equation solved for a different unknown — drill them separately.
The takeover price
The M&A face: what buying the WHOLE business costs once you assume its debts and pocket its cash.
EV/EBITDA
The comparison face: price per dollar of pre-financing earnings — leverage-neutral, so differently-financed twins score alike.
On the BA II Plus
Worked example: Market cap $2,650.00m, debt $220.00m, cash $300.00m, EBITDA $420.00m. What is the EV/EBITDA multiple?
- 1.2650 [+] 220 [−] 300 [=]enterprise value first
- 2.[÷] 420 [=]per dollar of EBITDA
→ 6.119