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Investment Risks and Returns Influence Business Valuation 

Investment Risks and Returns Influence Business Valuation

One factor that affects the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) or SDE (Sellers Discretionary Earnings) multiplier is the cost of capital, which is the minimum required rate of return for an investment. The cost of capital reflects the risk and opportunity cost of investing in a business, and it consists of two components: the cost of debt and the cost of equity. The cost of capital can vary depending on the capital structure, the industry, the economic conditions, and the specific characteristics of the business.

The greater the cost of capital, the lower the EBITDA/SDE multiplier and the business value derived. This is because a higher cost of capital implies a higher discount rate for the future cash flows of the business, reducing their present value. Conversely, a lower cost of capital implies a lower discount rate and a higher present value of the future cash flows. Therefore, a business with a lower cost of capital has a higher EBITDA/SDE multiplier and a higher business value than a business with a higher cost of capital, all else being equal.