Reading 42: Market-Based Valuation: Price and Enterprise Val 2010, including, interest, before, center

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Session 12: Equity Investments: Valuation Models
Reading 42: Market-Based Valuation: Price and Enterprise Value Multiples

LOS q: Discuss alternative definitions of cash flow used in price and enterprise value multiples (including enterprise value to earnings before interest, taxes, depreciation, and amortization EV/EBITDA), and explain the limitations of each.

 

 

 

Which of the following measures of cash flow is most closely linked with valuation theory?

A) Free cash flow to equity (FCFE).

B) Cash flow from operations (CFO).

C) Earnings before interest, taxes, depreciation, and amortization (EBITDA).

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FCFE is most strongly linked to valuation theory. Both remaining proxies are in need of significant adjustment to accurately measure cash flow in valuation.

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If cash flow from operations (CFO) embeds financing-related flows, it should be adjusted by:

A) subtracting (net interest outflow) × (1 - tax rate).

B) adding (net interest outflow) × (1 - tax rate).

C) subtracting capital expenditures.

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Cash flow from operations CFO should be adjusted to CFO + (net cash interest outflow) × (1 – tax rate), if CFO embeds financing-related flows.

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Earnings before interest, taxes, depreciation, and amortization (EBITDA) is best suited as a measure of:

A) total company value.

B) equity value.

C) debt capacity.

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EBITDA is a pre-tax, pre-interest measure, which represents a flow to both equity and debt. Thus, it is better suited as an indicator of total company value than just equity value.