376  Using Multiples
Choosing between EBITA and EBITDA
A common alternative to the EBITA multiple is the EBITDA multiple. Many 
practitioners use EBITDA multiples because depreciation is, strictly speaking, 
a noncash expense, reflecting sunk costs, not future investment. This logic, 
however, does not apply uniformly. For many industries, depreciation of ex-
isting assets is the accounting equivalent of setting aside the future capital ex-
penditure that will be required to replace the assets. Subtracting depreciation 
from the earnings of such companies therefore better represents future cash 
flow and consequently the company’s valuation.
To see this, consider two companies that differ in only one aspect: in-house 
versus outsourced production. Company A manufactures its products using 
its own equipment, whereas Company B outsources manufacturing to a sup-
plier. Exhibit 18.6 provides financial data for each company. Since Company 
A owns its equipment, it recognizes significant annual depreciation—in this 
case, $200 million. Company B has less equipment, so its depreciation is only 
$50 million. However, Company B’s supplier will include its own deprecia-
tion costs in its price, and Company B will consequently pay more for its raw 
materials. Because of this difference, Company B generates EBITDA of only 
$350 million, versus $500 million for Company A. This difference in EBITDA 
will lead to differing multiples: 6.0 times for Company A versus 8.6 times for 
Company B. Does this mean Company B trades at a valuation premium? No, 
when Company A’s depreciation is deducted from its earnings, both compa-
nies trade at 10.0 times EBITA.
Exhibit 18.6  Enterprise-Value-to-EBITDA Multiple Distorted by Capital Investment
$ million
Company A
Company B
Company A
Company B
Income statement
Free cash flow
Revenues
1,000 
1,000 
NOPAT
210 
210 
Raw materials
(100)
(250)
Depreciation
200 
50 
Operating costs
(400)
(400)
Gross cash flow
410 
260 
EBITDA
500 
350 
Investment in working capital
(60)
(60)
Depreciation
(200)
(50)
Capital expenditures
(200)
(50)
EBITA
300 
300 
Free cash flow
150 
150 
Operating taxes
(90)
(90)
Enterprise value
3,000 
3,000 
NOPAT
210 
210 
Multiples, times
EV/EBITA
10.0
10.0
EV/EBITDA
6.0
8.6

Use Net Enterprise Value Divided by Adjusted EBITA or NOPAT   377
When computing the EV-to-EBITDA multiple in the previous example, we 
failed to recognize that Company A (the company that owns its equipment) 
will have to expend cash to replace aging equipment: $200 million for Com-
pany A versus $50 million for Company B (see the right side of Exhibit 18.6). 
Since capital expenditures are recorded in free cash flow and not NOPAT, the 
EBITDA multiple is distorted.
We came across an interesting example in a processing industry, as shown 
in Exhibit 18.7. On an EV-to-EBITDA basis, Company M trades at a multiple 
of 6.3 times, far below its peers’ multiples of 8.1 to 10.2 times. However, on 
an EV-to-EBITA basis, it actually trades at the high end of its peers. In this in-
dustry, companies have to replace depreciated assets constantly, so the EBITA 
multiple provides a better comparison of valuation levels. In Company H’s 
case, its low cash margins also contribute to the larger gap between EBITA 
and EBITDA.
In some situations, EBITDA scales a company’s valuation better than 
EBITA. These occur when current depreciation is not an accurate predictor 
of future capital expenditures. For instance, consider two companies, each of 
which owns a machine that produces identical products. Both machines have 
the same cash-based operating costs, and each company’s products sell for 
the same price. If one company paid more for its equipment (for whatever 
reason—perhaps poor negotiation), it will have higher depreciation and, thus, 
lower EBITA. Valuation, however, is based on future discounted cash flow, not 
past profits. And since both companies have identical cash flow, they should 
have identical values.6 We would therefore expect the two companies to have 
identical multiples. Yet, because EBITA differs across the two companies, their 
multiples will differ as well.
Exhibit 18.7  Company M Peer Multiples Comparison
Company B
Company L
Company H
Company C
Company M
8.1
8.4
9.0
10.2
6.3
12.0
11.3
13.5
16.3
16.0
EV/EBITDA, 2015E
EV/EBITA, 2015E
 
6 Since depreciation is tax deductible, a company with higher depreciation will have a smaller tax 
burden. Lower taxes lead to higher cash flows and a higher valuation. Therefore, even companies with 
identical EBITDAs will have different EBITDA multiples. The distortion, however, is less pronounced.