A Michigan-based manufacturing business had been in existence for over 50 years. The third-generation owners were thinking of selling. The business had generated around $3 million of EBITDA for each of the previous three years. Similar companies were selling between 4.5 to 5 times EBITDA suggesting an upside value in the $15 million range.
The owners, however, believed that the cost to replicate 50 years’ worth of equipment investments would exceed $60 million. While the balance sheets showed all assets had been fully depreciated, the owners insisted replacement cost was the appropriate valuation metric to use.
The math would imply otherwise. Assume EBITDA was $3 million per year and the purchase price was $60 million as the sellers believed. The annual return on investment would be $3 million / $60 million = 5%. Most private company investors are seeking investment returns in excess of 20%. Consequently, no investor would commit $60 million to earn 5%.
The sellers argued, “But it really would cost $60 million to replicate this facility with all its equipment and improvements.” The rebuttal is that no one would want to replicate it if the most they could expect was a 5% return on investment.