Corporate and Project Finance Modeling

Chapter 36Developing Value Drivers for P/E and EV/EBITDA Ratios with Benchmarking and Regression

Creating models and functions to compute price/earnings (P/E) and enterprise value/earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) multiples does not address how to come up with value driver inputs that should be put into the analysis. Let's say that you have a good idea about the current EV/EBITDA multiple, and you only want to adjust the multiple for changes in items like a lower growth rate, a different cost of capital, or a lower return on invested capital (ROIC). The problem with putting values in one of the functions to compute multiples discussed in Chapters 34 and 35 is that you do not know the biggest factor that drives any of the multiples, namely the cost of capital. When implementing the computed multiples into corporate finance models, you could attempt to focus on incremental changes from the current market multiples rather than starting from scratch in building up the multiple. To do this you can use market data for multiples and make estimates of what you think the market expectations are for growth and return as well as other inputs like the tax rate and the plant life. With current multiples observed in the market you can then apply a Goal Seek process to find the implied weighted average cost of capital (WACC) or the implied cost of equity by moving the cost of capital around until the derived multiple equals the market observed value. ...