Dividing both sides by the expected free cash flow to the firm yields the Value/FCFF multiple for a stable growth firm:

Vo 1

Since the free cash flow the firm is the after-tax operating income netted against the net capital expenditures and working capital needs of the firm, the multiples of EBIT, after-tax EBIT and EBITDA can also be estimated similarly. The value/EBITDA multiple, for instance, can be written as follows: Value (1-t) + Depr (t)/EBITDA CEx/EBITDA ! Working Capital/EBITDA

The point of this analysis is not to suggest that we go back to using discounted cash flow valuation but to understand the variables that may cause these multiples to vary across firms in the same sector. If we ignore these variables, we might conclude that a stock with a PE of 8 is cheaper than one with a PE of 12, when the true reason may be that the latter has higher expected growth or we might decide that a stock with a P/BV

ratio of 0.7 is cheaper than one with a P/BV ratio of 1.5, when the true reason may be that the latter has a much higher return on equity. Table 12.7 lists the multiples that are widely used and the variables that determine each; the variable that, in our view, is the most significant determinant is highlighted for each multiple. This variable is what we would call the companion variable for this multiple, i.e., the one variable we need to know in order to use this multiple to find under or over valued assets.

38 In practice, cash and marketable securities are subtracted from firm value to arrive at what is called enterprise value. All the multiples in the following section can be written in terms of enterprise value, and the determinants remain unchanged.

Table 12.7: Multiples and Companion Variables (in italics)


Determining Variables

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