Normalizing EBITDA Jason Kidwell is considering whether to acquire a local toy manufacturing company, Toys n Things Inc. The companys annual income statements for three years are as follows:

Alternate View

	2014	2013	2012
Revenues	$ 2,243,155	$ 2,001,501	$ 2,115,002
Cost of goods sold	(1,458,051)	(1,300,976)	(1,374,751)
Gross profits	$ 785,104	$ 700,525	$ 740,251
Depreciation and administrative expenses	(574,316)	(550,150)	(561,500)
Net operating income	$ 210,798	$ 150,375	$ 178,751

Jason has learned that small private companies such as this one typically sell for EBITDA multiples of three to four times. Depreciation expense equals $50,000 per year. What value would you recommend Jason put on the company?

The current owner of Toysn Things indicated to Jason that he would not take less than five times 2014 EBITDA to sell out. Jason decides that, based on what he knows about the company, the price could not be justified. However, upon further investigation, Jason learns that the owners wife is paid $100,000 a year for administrative services that Jason thinks could be done by a $50,000-per-year assistant. Moreover, the owner pays himself a salary of $250,000 per year to run the business, which Jason thinks is at least $50,000 too high based on the demands of the business. In addition, Jason thinks that, by outsourcing raw materials to Asia, he can reduce the firms cost of goods sold by 10%. After making adjustments for excessive salaries, what value should Jason place on the business? Can Jason justify the value the owner is placing on the business?

Given
Cost of goods sold/Revenues	65%
Fixed operating costs	$ 350,000
Variable operating costs/Revenues	10%
Depreciation expense	$ 50,000
Salary adjustments	$ 100,000
Annual outsourcing savings/Revenues	10%
Historical Incomes Statements for Toys 'n Thing, Inc.
	2014	2013	2012
Revenues	$ 2,243,155	$ 2,001,501	$ 2,115,002
Cost of goods sold	(1,458,051)	(1,300,976)	(1,374,751)
Gross profits	785,104	700,525	740,251
General and Administrative Expenses*	(574,316)	(550,150)	(561,500)
Net Operating Income	$ 210,789	$ 150,375	$ 178,751
*Includes depreciation expense of $50,000 per year.
Solution
a.		Years
		2014	2013	2012
Net Operating Income		$ 210,789	$ 150,375	$ 178,751
Plus: Depreciation expense		50,000	50,000	50,000
EBITDA		$ 260,789	$ 200,375	$ 228,751
Valuation	EBITDA Multiple	2014	2013	2012
	3
	4
Average
b.
		2014	2013	2012
EBITDA		$ 260,789	$ 200,375	$ 228,751
Plus: Salary adjustments		100,000	100,000	100,000
Plus: Outsourcing savings
Adjusted EBITDA
Valuation	EBITDA Multiple	2014	2013	2012
	3
	4
Average
Asking price = 5 x 2010 Unadjusted EBITDA
Estimated value after adjustments