Archive / Research Analyst / Valuation Principles
nism-series-xv-ev-ebitda-vs-pe-multiple-cross-border[ RESEARCH ANALYST ]
Why is the EV/EBITDA valuation multiple widely preferred over the PE ratio when evaluating cross-border peers or potential Mergers & Acquisitions (M&A) takeover targets in capital-intensive industries?
[ A ]Because EBITDA is legally guaranteed by SEBI to be 100% accurate without auditing.
[ B ]Because EV/EBITDA eliminates all trading commissions paid on the National Stock Exchange.
[ C ]Because EV/EBITDA can only be calculated when a company reports severe negative revenues.
[ D ]Because EV/EBITDA is capital structure neutral (unaffected by leverage differences) and operating asset neutral (unaffected by differing depreciation policies or tax regimes across borders).[ CORRECT ]
Takeaway
Option D is correct: Because EV/EBITDA is capital structure neutral (unaffected by leverage differences) and operating asset neutral (unaffected by differing depreciation policies or tax regimes across borders).
Derivation
EV/EBITDA compares total operating firm value (Enterprise Value = Equity + Debt - Cash) to pre-interest, pre-tax, and pre-depreciation cash generation (EBITDA). It is superior to the P/E ratio for M&A and cross-border comparisons because: (1) Capital Structure Neutrality: Highly leveraged companies have depressed PAT due to interest expenses (inflating PE), whereas EV/EBITDA evaluates the entire enterprise regardless of how it is financed. (2) Accounting Neutrality: Different depreciation methodologies (SLM vs WDV) or tax rates distort net profit but leave EBITDA unaffected. This tests EV/EBITDA rationale. The common error is assuming PE is universally superior.
Why the others fail
A — Because EBITDA is legally guaranteed by SEBI to be 100% accurate without auditing.
EBITDA is an accounting financial metric derived from company filings and is not guaranteed by securities regulators.
B — Because EV/EBITDA eliminates all trading commissions paid on the National Stock Exchange.
Valuation multiples evaluate asset worth and have no bearing on stock exchange secondary trading commissions.
C — Because EV/EBITDA can only be calculated when a company reports severe negative revenues.
EV/EBITDA requires positive operating earnings and is applied to profitable capital-intensive going concerns, not negative revenue entities.
Related questions
nism-series-xv-capm-cost-of-equity-exampleResearch Analyst
How Do You Calculate Cost of Equity Using CAPM?nism-series-xv-terminal-value-perpetual-growth-dcfResearch Analyst
How Is Terminal Value Computed in a Two-Stage DCF Model?nism-series-xv-sum-of-the-parts-sotp-conglomerate-valuationResearch Analyst
How Do Analysts Value a Conglomerate Using Sum-Of-The-Parts?