Assume that the following two companies are in the same industry, have the same

Question

Assume that the following two companies are in the same industry, have the same EBITDA and similar growth profile. The main difference is the capital expenditure as shown below. Based on the EV/EBIT multiple, which company is more likely to trade at a premium?  

Company A: Large capital expenditure to buy new equipment/machinery in recent years, resulting in increased depreciation for the current and future years.

Company B: Deferred in capital spending until a future period, resulting in small amount of depreciation /amortization

Explanation / Answer

EBIT = EBITDA – Depreciation and Amortization

If there is high depreciation, then EBIT is likely to be lower for similar companies having similar EBITDA margins.

With a lower EBIT, EV/EBIT would be higher and a higher EV/EBIT implies trading at a higher premium.

In this case, since Company A has large capital expenditure to buy new equipment/machinery in recent years, resulting in increased depreciation for the current and future years, so EBIT would be lower.

Consequently, EV/EBIT would be high and that means Company A would be trading at a greater premium.

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