valuation multiple and tax shield
Hello,
I'm wondering if we should consider the multiple
=> NI to common without tax shield / Equity value,
=> instead of NI to Common including tax shield / Equity Value (which is more traditional = easily comparable to market data)
My reasoning:
When using an implied multiple, to get an apple-to-apple comparison, we should have:
- a numerator excluding a value (e.g. financial interest) and a denominator including it (e.g. debt)
=> EBITDA (excludes fin interest) / Enterprise value (includes financial debt)
- a numerator including a value (e.g. financial interest) and a denominator excluding it (e.g. debt)
=> NI (includes financial interest) / Equity value (excludes financial debt)
=> NI to Common (includes preferred dividend, = after in P&L) / equity value (= excludes preferred stock)
etc
But when considering an existing value of tax shield, I understand the levered financial structure value is higher. This increase benefits to all investors, including ultimately the shareholder.
So the ratio NI to Common (= includes tax shield effect) / Equity Value (includes VTS) should not be considered?
Thank you for your thoughts on this.
Kind regards
Couple clarifications: It's EV / EBITDA It's Price / EPS (P/E), I know that it's the same thing, but you're going to get some blank stares if you say equity value / NI.
You're thinking about this the wrong way. You're not excluding interest in EBITDA, you're excluding the EFFECT of interest expense. You know it's in there, you just don't care about how much it is. Same idea for net income, you're removing the effect of debt on earnings and then comparing that debt-less measure with equity value.
To summarize EBITDA >> interest is still in there >> applies to equity and debt EV >> equity and debt are accounted for Net Income >> interest has been subtracted out so only equity cash flows are affected Equity value >> self-explanatory
Thanks for clarifications. I wrote a too long intro. Actually my main interrogation remains: should we consider NI out of tax shield to get an apple-to-apple calculation? (equity value / Ni to Common net of tax shield)
No. Say you have 100 of interest, 30% tax rate and 1000 of EBIT.
NOPAT (used for FCFF) would be 1000(1-t) = 700 Net Income (FCFE) would be 1000-100=900(1-t) = 630.
Why would you take out the tax shield of 30? The interest is a payment to debtholders, in addition to the repayment of the balance that they contributed. They were paid their locked-in amount (under their terms with the borrower) and that's all they get, they don't get any credit for the tax shield, they have essentially no rights as long as they're getting paid.
Everything else after the debthlolders gets paid goes to equity. That tax shield is a small benefit for the company/equity to gain from using debt. If there was no advantage to using debt then no one would use it.
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