Cost of debt and EBITDA multiple: Difference between pages

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(Kd(1-t)).
1.


A method of entity business valuation which is based on:


== Definition of Cost of debt ==
(i) Accounting Earnings before interest, tax, depreciation and amortisation (EBITDA) and
The component of a firm's Weighted average cost of capital which relates to the servicing of the firm's providers of debt capital. 


The calculation of the current market cost of debt is based on the Market <u>Yield to maturity</u> of any debt currently in issue.
(ii) The ratio of entity value to EBITDA of a comparable business (or a comparable group of businesses).


This will normally be different from the <u>interest rate</u> on the debt, which is <u>not</u> the relevant measure for investment decision making purposes.


EBITDA multiple = Total value of firm ÷ EBITDA.


== Simple calculation of corporate tax relief ==
The calculation should also take account of related corporate tax relief on the debt servicing costs. 


Hence the '( 1 - t )' term in Kd( 1 - t ).
2.


Cost of debt is often denoted more simply as 'Kd'.  However this is not best practice, because it may be ambiguous whether the 'Kd' figure is stated before or after the related tax relief.
For example, the total entity value of Company A is $750m and its relevant EBITDA is $150m.


Company A's EBITDA multiple:


<span style="color:#4B0082">'''Example'''</span>
= $750m/$150m


Say the relevant cost of debt is 5% per annum before tax relief, all debt servicing costs are fully tax relieved at 28%, and there are no timing differences between paying the debt servicing costs and enjoying the related tax relief,
= 5 times.


Kd( 1 - t ):


= 5 x ( 1 - 0.28 )
3.


= 3.6%.
The EBITDA multiple can also be used as a very simple comparison or estimation model, for corporate valuation.


In another case, say comparable EBITDA multiples for an unlisted Company B are 6, and its relevant EBITDA is $30m.


== Stricter treatment of related tax relief ==
The total entity value of Company B's business can be estimated on this basis as:
More strictly, the related tax relief should be factored into the net cost of debt calculation by taking account of any timing differences between the debt servicing cash outflows and the related tax savings.


6 x $30m


== See also ==
= $180m.
* [[Cost of equity]]
* [[Weighted average cost of capital]]
* [[Yield to maturity]]


[[Category:Accounting,_tax_and_regulation]]
 
==See also==
* [[Earnings multiples]]
* [[EBITDA]]
* [[Price to earnings ratio]]

Revision as of 16:31, 19 November 2014

1.

A method of entity business valuation which is based on:

(i) Accounting Earnings before interest, tax, depreciation and amortisation (EBITDA) and

(ii) The ratio of entity value to EBITDA of a comparable business (or a comparable group of businesses).


EBITDA multiple = Total value of firm ÷ EBITDA.


2.

For example, the total entity value of Company A is $750m and its relevant EBITDA is $150m.

Company A's EBITDA multiple:

= $750m/$150m

= 5 times.


3.

The EBITDA multiple can also be used as a very simple comparison or estimation model, for corporate valuation.

In another case, say comparable EBITDA multiples for an unlisted Company B are 6, and its relevant EBITDA is $30m.

The total entity value of Company B's business can be estimated on this basis as:

6 x $30m

= $180m.


See also

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