What is Enterprise Value to EBIT?

                                                    

 

Meaning

It means the ratio between two elements that are Enterprise Value (EV) and Earnings before Interest and Taxes (EBIT). 

This ratio is used to determine whether the stock is over-priced or under-priced relative to the market and other stocks. It is similar to the PE ratio and overcomes the limitations of the latter.

Applications

1.      It is used to compare the relative value of different companies with similar financial, operating, and ownership profiles.

2.      Typically it is used in relative business valuation models.

3.      High ratio indicates the company’s stock is overvalued. Conversely, the low ratio indicates the company’s stock is undervalued.

4.      It is a significant ratio because it is applied in case of merger, acquisition, or takeover to determine what is the actual swap ratio.

How to calculate?

Enterprise Value (EV) = Market Cap + Market Value of Debt-All Cash and Cash Equivalents

Where,

Market Cap = Market Price of Share*No of Outstanding Shares

 

Example

Suppose Company A wants to take over company B. 

There are three companies that have similar financial, operating, and ownership characteristics namely Companies X, Y & Z. 

The EV/EBIT ratios for the companies are 10, 12 & 14 respectively. 

The finance expert can apply the average i.e. 12 times to company B’s EBIT to find its EV.

Then the value of equity and share price is determined.

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