374  Using Multiples
Since the blend of debt at 20 times and pretax equity must equal the enterprise 
value at 10 times, the pretax equity multiple must drop below 10 times to 
offset the greater weight placed on high-multiple debt.5 The opposite is true 
when enterprise value to EBITA exceeds the ratio of debt to interest expense 
(less common, given today’s low interest rates). Company D has a higher P/E 
than Company C because Company D uses more leverage than Company C. 
In this case, a high pretax P/E (greater than 25 times) must be blended with 
the debt multiple (20 times) to generate an EV-to-EBITA multiple of 25 times.
Why Not EV to EBIT?
It’s clear that shifting to enterprise-value multiples provides better insights 
and comparisons across peer companies. The next question is what measure 
of operating profits to use in the denominator—EBIT, EBITDA, EBITA (ad-
justed), or NOPAT? We recommend EBITA or NOPAT.
The difference between EBIT and EBITA is amortization of intangible as-
sets. Most often, the bulk of amortization is related to acquired intangible 
assets, such as customer lists or brand names. Chapter 11 explained why we 
exclude amortization of acquired intangibles from the calculation of ROIC 
and free cash flow. It is noncash, and, unlike depreciation of physical assets, 
the replacement of these intangible assets is already incorporated in EBITA 
through line items such as marketing and selling expenses. So using EBITA is 
preferred, both from a logical perspective and because it leads to more com-
parable multiples across peers.
To illustrate the distortion caused by amortization of acquired intangible 
assets, we compare two companies with the same size and underlying operat-
ing profitability. The difference is that Company A achieved its current size 
by acquiring Company B, whereas Company C grew organically. Exhibit 18.5 
compares these companies before and after A’s acquisition of B.
Concerned that its smaller size might lead to a competitive disadvantage, 
Company A purchased Company B. Assuming no synergies, the combined 
financial statements of Companies A and B are identical to Company C’s with 
two exceptions: acquired intangibles and amortization. Acquired intangibles 
are recognized when a company is purchased for more than its book value. In 
this case, Company A purchased Company B for $1,000 million, which is $750 
million greater than its book value. If these acquired intangibles are separable 
and identifiable, such as patents, Company A + B must amortize them over 
the estimated life of the asset. Assuming an asset life of ten years, Company A 
+ B will record $75 million in amortization each year.
5 Appendix D derives the explicit relationship between a company’s actual P/E and its unlevered P/E, 
that is, the P/E as if the company were entirely financed with equity. For companies with large unle-
vered P/Es (i.e., companies with significant opportunities for future value creation), P/E systemati-
cally increases with leverage. Conversely, companies with small unlevered P/Es would exhibit a drop 
in P/E as leverage rises.

Use Net Enterprise Value Divided by Adjusted EBITA or NOPAT   375
The bottom of Exhibit 18.5 reports enterprise value multiples using EBITA 
and EBIT, both before and after the acquisition. Since all three companies gen-
erated the same level of operating performance, they traded at identical mul-
tiples before the acquisition, 10 times EBIT (and EBITA). After the acquisition, 
the combined Company A + B should continue to trade at a multiple of 10 
times EBITA, because its performance is identical to that of Company C. How-
ever, amortization expense causes EBIT to drop for the combined company, 
so its EV-to-EBIT multiple increases to 16 times. This rise in the multiple does 
not reflect a premium, however (remember, no synergies were created). It is 
merely an accounting artifact. Companies that acquire other companies must 
recognize amortization, whereas companies that grow organically have none 
to recognize. To avoid forming a distorted picture of their relative operating 
performance, use EV-to-EBITA multiples.
In limited cases, companies will capitalize organic investments in intan-
gible assets. For example, telecommunication service providers capitalize the 
purchase costs for spectrum licenses and then amortize them over their use-
ful life. In a similar way, development costs for software that is to be sold or 
licensed to third parties can be capitalized and amortized under IFRS and U.S. 
GAAP if certain conditions are met. In such cases, the amortization charges 
are operating costs and should be separated from acquisition amortization. 
Just like depreciation charges, operating amortization should be included in 
adjusted EBITA.
Exhibit 18.5  Enterprise-Value-to-EBIT Multiple Distorted by Acquisition Accounting
$ million
Before acquisition
After A acquires B
Company A
Company B
Company C
Company A + B
Company C
EBIT
Revenues
375 
125 
500 
500 
500 
Cost of sales
(150)
(50)
(200)
(200)
(200)
Depreciation
(75)
(25)
(100)
(100)
(100)
EBITA
150
50
200
200
200
Amortization
– 
– 
– 
(75)
– 
EBIT
150 
50 
200 
125
200 
Invested capital
Organic capital
750 
250 
1,000 
1,000 
1,000 
Acquired intangibles
– 
– 
– 
750 
– 
Invested capital
750 
250 
1,000 
1,750 
1,000 
Enterprise value
1,500 
500
2,000 
2,000 
2,000 
Multiples, times
EV/EBITA
10.0 
10.0
10.0
10.0
10.0
EV/EBIT
10.0
10.0
10.0
16.0
10.0