Introduction to Corporate Finance

5: Valuing Shares

Vcompany A = Vshares + Vdebt = (100,000,000 × $5) + $100,000,000 = $600,000,000

Next, divide this figure by total revenues or by EBITDA to obtain the desired multiple:

Value

Revenues

$600,000,000

$100,000,000

==6.0

Value

EBITDA

$600,000,000

$68, 000 ,000

==8. 8

Repeating these calculations for companies B and C, we obtain the results shown in Table 5.2).

tABLE 5.2

Equity value

($ millions)

Company value

($ millions)

Value-to-revenue

multiple

Value-to-EBITDA

multiple

Company A $500 $600 6.0 8.8

Company B 400 550 5.8 8.5

Company C 375 575 3.8 9.1

Average 5.2 8.8

Now, simply use the average value of each multiple to estimate the total company value for Smart Phonz
(see Table 5.3). Based on the multiple of company value to revenues, Smart Phonz should be worth about
$1.014 billion ($195 million times 5.2), and based on the multiple of company value to EBITDA, the value
of Smart Phonz is slightly lower at $924 million ($105 million times 8.8). You might then conduct a separate
discounted cash flow valuation of Smart Phonz to see whether that estimate is also roughly in line with the
estimate of about $1 billion that you just calculated based on multiples.

tABLE 5.3

Smart Phonz valuation based on:

Revenues ($ millions) EBITDA ($ millions)

Average comparable multiple 5.2 8.8

Smart Phonz operating metric $195 $105

Estimated value of Smart Phonz $1,014 $924

If you wanted to estimate the equity value of Smart Phonz, you could simply subtract its debt value from
the enterprise values just calculated. This indicates that Smart Phonz’s equity is worth about $900 million ($1
billion enterprise value minus $100 million debt). Alternatively, you could calculate the equity value directly using
equity comparable multiples, such as the P/E ratio (the price per share of ordinary shares divided by earnings
per share). It is important to recognise that if equity value is in the numerator of the ratio (‘price’ in the P/E ratio),
then to make the ratio apples-to-apples, the denominator must represent a flow that goes to shareholders only
(‘earnings’ in the P/E ratio). That is, if the numerator is share price, you should not use a number like EBITDA in
the denominator, because EBITDA can be used to pay both shareholders and bondholders.^12
To summarise, if share price or total equity value is in the numerator of the comparable multiple, then use
a denominator that is associated only with equity holders (like earnings or book equity). In contrast, in the
calculations done in the tables above, because total company value was in the numerator of the comparable
multiple, we used a denominator (EBITDA) that is associated with all investors, both bondholders and
shareholders.

12 Earnings before interest, taxes, depreciation and amortisation (EBIDTA) represents funds that can be used to pay bondholders (via debt
interest), government (via taxes), shareholders (via earnings that can be paid out as dividends), and ‘real capital’ (via the depreciation and
amortisation).

example