Business Valuation

CHAPTER 10Market Approach and Methods

PYRAMID STEP 10 Interpret and apply market data.

The market approach is closely related to the income approach in that they both use a specified benefit stream and associated risk of achieving that benefit consistently. In the market approach, this relationship is reflected through the use of market multiples, which incorporate a benefit stream (e.g., revenue; earnings before interest, taxes, depreciation, and amortization (EBITDA); or net income) and an implied risk component derived from comparable market data. A market multiple is calculated by dividing a value driver—such as the market value of invested capital (MVIC) or equity value of comparable companies—by a corresponding benefit measure. While these multiples are mathematically ratios, they are typically presented as a whole number, such as “5X EBITDA.” The inversion of the multiple provides an estimate of the implied cost of capital or risk rate from the peer comps. With a 5X EBITDA multiple, the implied cost of capital (capitalization rate) is 1/5 = 20%.

The market approach includes two primary methods:

1. The completed transaction method (CTM), based on the market pricing of completed acquisitions of comparable businesses.
2. The guideline public company method (GPCM), based on the market pricing of publicly traded companies with similar characteristics.

Both methods require the ...