Questions: Enterprise Value and Valuation Multiples
5 questions to test your understanding
Score: 0 / 5
Question 1 Multiple Choice
Company A and Company B have identical operating businesses with the same EBITDA. Company A is entirely equity-financed; Company B carries significant debt. An analyst compares them using P/E ratios and finds Company B has a much higher P/E. What best explains why this comparison is misleading?
AP/E ratios cannot be computed for companies that have debt outstanding
BInterest expense reduces Company B's earnings, making its P/E artificially high even though both businesses are equally valuable. EV/EBITDA would show equal multiples because it measures value relative to pre-financing operating profit
CThe analyst should use market cap directly, not P/E, when comparing levered and unlevered firms
DP/E is always more accurate than EV/EBITDA; the analyst should trust the P/E comparison
Interest expense is a financing cost, not an operating cost. Company B pays interest, which reduces its net income and raises its P/E (same business value, lower earnings denominator). But this reflects capital structure, not operating performance. EBITDA removes interest before computing the ratio, putting both companies on equal footing regardless of how they are financed. This is why EV/EBITDA is the standard for cross-company comparisons: it isolates the value of the operating business from financing choices.
Question 2 Multiple Choice
A company has a market capitalization of $800M, total debt of $300M, and $100M in cash. What is its enterprise value?
D$600M — market cap minus net debt ($300M − $100M)
EV = market cap + debt − cash = $800M + $300M − $100M = $1,000M. The logic: to acquire the entire company you buy all the equity ($800M) and assume the debt ($300M), but you also receive the company's $100M cash (which offsets your cost). Net acquisition cost = $1,000M. Cash is subtracted — not added — because the acquirer gains it. This is the most commonly confused computation: students who think of cash as 'more value to add' get it backwards — cash you inherit upon acquisition reduces your net cost.
Question 3 True / False
When calculating enterprise value, a company's cash is added to market cap and debt because cash represents additional value an acquirer captures.
TTrue
FFalse
Answer: False
Cash is SUBTRACTED in the EV formula: EV = market cap + debt − cash. When you acquire a company, you pay the market cap and take on the debt — but you also instantly own the cash. That cash offsets your cost, so it reduces EV. A company with $500M in cash sitting in an otherwise modest business has a lower EV than its market cap + debt would suggest, because the $500M is a financial asset that comes directly to you as the new owner. EV captures the price of the operating business, stripped of excess cash.
Question 4 True / False
Two companies in the same industry with identical EV/EBITDA multiples are necessarily fairly valued relative to each other.
TTrue
FFalse
Answer: False
EV/EBITDA normalizes for capital structure but not for differences in growth rates, margins, or capital intensity. A high-growth software company and a mature enterprise software vendor might both be labeled 'software,' but the former justifiably commands a premium multiple. Comparable company analysis requires selecting peers that are truly comparable on the dimensions that drive valuation — growth, profitability, competitive position, and capital requirements. Identical multiples between incomparable companies tells you nothing useful about relative fair value.
Question 5 Short Answer
Why does the enterprise value formula subtract cash and add debt, rather than treating them symmetrically as balance sheet items?
Think about your answer, then reveal below.
Model answer: Debt is added because it represents a claim on the business that an acquirer must assume — it is part of the total cost of buying the enterprise. Cash is subtracted because it is an asset the acquirer gains immediately upon purchase, directly offsetting the acquisition cost. The asymmetry reflects the distinction between financial liabilities (debt increases total cost) and financial assets (cash reduces net cost). EV = what you pay (equity + debt) minus what you instantly receive (cash) = the price of the underlying operating business, independent of its financing.
The formula aims to capture only the value of the operating business, stripped of pure financial claims. Cash could be distributed to shareholders today without affecting operations — it is not an operating asset. Debt reduces what equity holders receive. Together, EV strips both out so that two identical businesses with different amounts of cash or different capital structures compare at equal EV, enabling the apples-to-apples analysis that multiples like EV/EBITDA are designed to provide.