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CFA Level I · CFA Level I Exam · Relative Value Equity Valuation Approaches

An analyst values a firm using enterprise value to EBITDA rather than P/E. Which situation most likely makes EV/EBITDA the more appropriate choice?

EV/EBITDA is most appropriate when comparing firms in the same industry with substantially different leverage. Because EBITDA is before interest and EV includes debt, the multiple is less distorted by capital structure differences than P/E. It is generally unsuitable for financial institutions.

  1. AComparing firms with very similar capital structures and no debt.
  2. BComparing firms in the same industry with substantially different leverage.Correct
  3. CValuing a financial institution whose debt is operating raw material.

Explanation

EV/EBITDA is measured before interest and is based on total firm value, so it is less affected by differences in financial leverage than P/E. It is therefore useful when leverage differs substantially across comparable firms. It is generally unsuitable for financial institutions, where debt is an operating input.

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