I'm still in the basics of valuation and trying to learn the concepts. I came across this concept of adjusting the EBIT. So, tried performing the calculation on my own to value these 2 companies. Am I correct in my calculation?
(1) Company A: Owns PPE worth $ 1,000,000 with EBIT $500,000. PPE are used to perform the business operations
(2) Company B: Leases PPE on rent of $ 30,000/year and owns property valued at $ 200,000. EBIT $100,000
Assume both are competitors in the industry and a seller is willing to pay 3x EBIT. Would it be correct if I say the following?
(1) Valuation of Company A:
3 x 500,000 = 1,500,000 + 1,000,000 = $ 2.5 M
(2) Valuation of Company B:
3 x (100,000 - 30,000) = 210,000 + 200,000 = $ 410,000
If Company B leases all PPE, will it be correct if I say:
Valuation of Company B = 3 x (100,000 - 30,000) = 210,000 + 1,000,000 = $ 1.21 M
I'll appreciate your help and comments. Correct me if I'm missing something here.
Would love to hear your views
Company A should only be worth $1.5 million, you shouldn't add the PPE. You only want to add excess assets to the valuation; assets that could be sold without affecting the EBIT number you are using in the valuation. In this case, the $500K of EBIT you are projecting is only achievable by utilizing the $1M of PPE. Imagine a simple scenario, like a coffee shop with one machine; with the machine, you might generate $50K of earnings over the year. The machine is worth $5K. In valuing the shop, you would not add the $5K value of the machine to the value of the stream of $50K per year, because without the machine, you couldn't sell coffee. You can either use the machine to sell coffee and get a $50k per year income, or you could sell off the machine, but not both.
With Company B, unless otherwise stated, rent should be factored into EBIT already, so there'd be no need to subtract it out specifically. If the property the company owned is not utilized by the business, then in this case it does make sense to add on the value as an excess asset.
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