In a recent series of posts, we developed a means to develop direct and credible multiples of EBITDA applicable to specific valuation situations. This is important because EBITDA is part of the universal business language and is a term that appraisers, business owners and market participants understand. It is also important because until now, one way to capitalize EBITDA has been by using (often incomplete and/or dated) guideline transactions in other private or public companies. The other way has been through the use of guideline public companies, which may suffer in comparability based on size and many other differences.

Since writing the posts, I have had a number of opportunities to discuss the methodology with other appraisers and with clients. These conversations have encouraged me to write this single post to summarize this “new” method. In this post, we lay out the methodology for capitalizing EBITDA using the Adjusted CAPM in one place.

A key assumption necessary to develop capitalization rates and valuation multiples for capitalizing EBITDA is that of the EBITDA Depreciation Factor. We begin by examining the relationship between Earnings Before Interest and Taxes (EBIT) and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). We also test the general discussion with some market evidence.

Technically, there are three valuation approaches, the income approach, the market approach, and the asset approach. Within approaches, there are valuation methods. For example, the single period income capitalization method is a method within the income approach. Finally, there are techniques within methods. The single period income capitalization of net income or net cash flow is one such technique. This post introduces a single period income capitalization technique to capitalize EBITDA. It should be of interest to business owners, business appraisers and market participants.

Considering the foundation we have built in the last few posts, we can now, using the total capital version of the Gordon Model, build capitalization rates and multiples for EBIT and EBITDA. We discuss the various assumptions or calculations, which are found on the numbered rows in our example table.

A discount rate is a rate that is used to discount, i.e., to convert, expected future benefits into present value. The idea of present value is fairly intuitive: A dollar received today is worth more than a dollar to be received in a month or a year. Business appraisers “build” discount rates using a concept known as the Capital Asset Pricing Model (CAPM). We walk through its components using a risk-free rate as a foundation and adding premiums. Using our assumptions, we can then build-up a discount rate.