Valuation: The Market Approach

Appendix

Brief Derivation of the Respective Value Multiple’s Individual Value Drivers

Definitions:

EV	= Enterprise value (market value of operating/invested capital)
BEV	= Book enterprise value (book value of operating/invested capital)
P	= Price (market value of equity)
BV	= Book value of equity
Sales	= Revenues
EBIT	= Earnings before interest and tax
EBIT%	= EBIT margin
E	= Earnings after tax
FCFF	= Free cash flow to firm
FCFE	= Free cash flow to equity
WACC	= Weighted average cost of capital
Ke	= Cost of equity
g	= Growth rate
ROIC	= Return on invested capital (return on operating capital)
ROE	= Return on equity
T	= Tax rate
NIR	= Net investment ratio
RR	= Retention ratio

(a) EV/Sales

In its most basic form the value of a business enterprise (under a going concern assumption) is given by the discounted cash valuation flow model (i.e. “Gordon’s formula”):

FCFF₁ may be expressed as follows:

FCFF₀ may also be expressed as:

Substituting the term FCFF₁ in our cash flow valuation model (in Gordon’s formula) with the equivalents above, we reach the following:

Dividing both sides by Sales, we arrive at:

From that we can state that the EV/Sales multiple ...