How do I derive a justified EV/EBITDA multiple from fundamentals, rather than just using comps?

Deriving a justified EV/EBITDA from fundamentals is a powerful Level II skill that connects relative valuation to intrinsic value thinking.

The Approach: Start from a simple enterprise value model and express it in terms of EBITDA.

Step 1: Basic EV Formula EV = FCFF_1 / (WACC - g)

Where FCFF is free cash flow to the firm and g is the sustainable growth rate.

Step 2: Express FCFF in Terms of EBITDA FCFF = EBITDA x (1 - T)(1 - b) - Depreciation x T + Depreciation - CapEx - Change in WC

Simplifying with assumptions: FCFF ≈ EBITDA x [1 - Tax Rate x (1 - DA/EBITDA) - Reinvestment Rate]

Step 3: Divide Both Sides by EBITDA EV/EBITDA = FCFF/EBITDA / (WACC - g)

So the justified multiple depends on:

• FCFF-to-EBITDA conversion ratio (affected by tax rate, D&A intensity, reinvestment needs)
• WACC (cost of capital)
• g (growth rate)

Worked Example: Thunderbridge Industrials has:

• EBITDA: $500M
• Tax rate: 22%
• Depreciation: $120M (24% of EBITDA)
• CapEx: $150M (maintenance + growth)
• Change in working capital: $20M
• WACC: 9%
• Sustainable growth: 3%

FCFF = $500M x (1 - 0.22) -$150M - $20M +$120M x 0.22 FCFF = $390M -$150M - $20M +$26.4M = $246.4M

FCFF/EBITDA = $246.4M /$500M = 0.493

Justified EV/EBITDA = 0.493 / (0.09 - 0.03) = 0.493 / 0.06 = 8.2x

What Drives the Multiple Higher:

Factor	Effect on EV/EBITDA
Higher growth (g)	Higher multiple
Lower WACC	Higher multiple
Lower tax rate	Higher multiple
Lower reinvestment needs	Higher multiple
Higher D&A as % of EBITDA	Higher multiple (more tax shield)

Exam Application: If a comparable company analysis gives you 10x but the justified multiple is 8.2x, the stock may be overvalued relative to its fundamentals. This bridges the gap between relative and intrinsic valuation.

Practice justified multiple derivations in our CFA Level II question bank.