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

Company X and Company Y have identical enterprise values and revenues. Company X has higher EBITDA because it capitalizes a larger share of its operating costs, while Company Y expenses similar costs immediately. Holding all else equal, which conclusion is most likely?

Company X will appear to have a lower EV/EBITDA, which may overstate how cheap it is. Capitalizing costs raises reported EBITDA because the later amortization is excluded, while enterprise value is unchanged. The difference reflects accounting policy rather than economics, so comparability is impaired.

  1. ACompany X will appear to have a lower EV/EBITDA than Company Y, which may overstate its relative cheapnessCorrect
  2. BCompany X will appear to have a higher EV/EBITDA than Company Y, because capitalized costs raise enterprise value
  3. CCompany X and Company Y will show the same EV/EBITDA, because EBITDA excludes depreciation and amortization

Explanation

Capitalizing costs moves them out of operating expenses into assets, raising EBITDA (the later amortization is excluded from EBITDA). With the same EV, X's higher EBITDA gives a lower multiple, so it looks cheaper only because of accounting choices. Enterprise value is not changed by capitalization, and the multiples are not equal.

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