Interview question on multiples

1. EV/EBITDA = 5x, EV/Sales = 10x. That means EBITDA Margin = EBITDA/Sales = 200%. The result is quite weird. I believe that you mixed up the relative magnitude of multiples. The question is simple mathematical manipulation.

2. EV also represents the potential total acquisition cost of the target company.

Hope this helps.

Thank you for your answer

Yea, perhaps the interviewer mixed up EBITDA and Sales multiples.

Another way to think about EV is that it represents the value of the Company's operating assets.

Agree with above posters - conceptually you can answer the first question, but the multiples you were given are wrong. You can't have gross or EBITDA margins that exceed 100% of sales. EBITDA is sales minus operating expenses plus interest, taxes, depreciation and amortization. Here's an example of a basic income statement through EBITDA:

$100MM Sales

- $60MM Cost of Goods Sold

= $40MM Gross Profit (40% gross margins; $40MM Gross Profit divided by $100MM Sales)

- $30MM Operating Expenses (excluding interest, taxes, depreciation and amortization)

$10MM EBITDA (10% EBITDA margin; $10MM EBITDA divided by $100MM Sales)

EBITDA margin can be negative if expenses exceed revenue, but you can't have negative expenses so EBITDA will never be higher than sales (leading to EBITDA margins >100%). Therefore, multiples of EBITDA will always be higher than multiples of sales because even the most profitable business models have expenses.

To answer the multiple question, margins (EBITDA or gross) are just a ratio. No matter what the enterprise value is in dollars, the ratio won't change.

For example, say the company above is valued at a $100MM enterprise value (EV) $100MM (EV) / $100MM (Sales) = 1.0x EV / Sales multiple $100MM (EV) / $10MM (EBITDA) = 10.0x EV / EBITDA multiple EBITDA margins are 10%

If the company above was valued at $250MM $250MM (EV) / $100MM (Sales) = 2.5x EV / Sales multiple $250MM (EV) / $10MM (EBITDA) = 25.0x EV / EBITDA multiple EBITDA margins are still 10%

If you are just given the multiples with no sales, EBITDA or EV in dollar terms, pick an EV and work backwards. Correcting the example above, say EBITDA multiple is 10x and Sales multiple is 5x (again sales multiple can't be higher than EBITDA multiple). Value the company at $100MM.

$100MM EV divided by 10x EBITDA multiple = $10MM EBITDA $100MM EV divided by 5x Sales Multiple = $20MM sales $10MM of EBITDA divided by $20MM of sales is a 50% EBITDA margin

Try the math above with a $200MM enterprise value and you will get the same EBITDA margin of 50%. Margin is just a ratio - you can always calculate the ratio, but you wouldn't be able to give EBITDA, sales or enterprise value in dollar terms without additional info.

Sorry for the long post, but hope this helps.

Use sales multiple / ebitda multiple as a quick method for determining EBITDA margins.

You want to know enterprise value not just because that's the value of the business, but that is the first step in working out how you are going to finance the deal.

For example, if you started by valuing a middle market industrials company with a EBITDA of, say, around $60m, at EV of 8x, you can then tell your client that they can likely raise 4 - 5x first lien debt against that position in today's market, perhaps another 1 - 1.5x turns of 2/L or preference equity, depending on the competitive position etc.

That means the client needs to put in 1.5 - 3x equity. You'd then tell your client that, in today's market, they'd likely need to put in at least 35% of equity ie 2.8x. So that caps leverage at around 5.2x, which probably feels about right. You then calculate your likely DCM fees off that number (x your expected economics).

(EDIT: On review, I see I'm saying you could lever this credit up to 6.5x. That's not likely in today's market)

You should have a feel for the market interest rates. For, say, a mid-market B/B2 credit with a reputable sponsor, reasonable market dynamics and competitive position, let's call it at L+600 at 98.5 OID pricing on 4x 1/L, L + 1100 at 97 OID on 1.2x 2/L (my pricing may be a little out of date).

If the client is a PE sponsor, can the client meet their fund's return hurdles, assuming an exit in 4 - 5 years, some sales growth at GDP growth rates rate + some margin improvement, perhaps some EBITDA multiple expansion? You've got the key elements for a back of envelope calculation based on the thinking outlined above.

So you can work out whether the deal is financeable or not all from that EV starting point, with a few declared assumptions.

Not that you'd be expected to jot that stuff down and come up with an answer to the "financeable?" question in the interview, but running through the logic sets out above gives the interviewer a clear picture why you know bankers focus on EV, EBITDA and multiples.

Some good resources on understanding the meaning and drivers of an EBITDA multiple:

https://www.wallstreetprep.com/blog/my-ebitda-multiple-is-bigger-than-y… http://pages.stern.nyu.edu/~adamodar/New_Home_Page/lectures/vebitnote.h…

Theoretically speaking, as an extreme example, a very risky company with no expected growth should have an EBIT multiple close to 1, assuming no taxes. This is intuitive - the company costs as much as one year of EBIT. As the company becomes less risky, growth expectations increase, or efficiency increases (higher ROIC), the multiple increases from 1 correspondingly