MULTIPLE OF EARNINGS
A multiple of earnings is frequently used to value publicly owned companies because the technique is simple and direct. The first step is to figure normal earnings and then capitalize them at some rate of return or at a multiple of earnings. The rate of return or multiple used is based on assumptions about the company's risk level and projected future earnings, so the greater the potential earnings, the higher the mul¬tiple will be. Similarly, the greater the risk, the lower the multiple. Table 17.1 pres¬ents some information used to calculate the value of a hypothetical company.
A variation of this method, which typically results in a higher valuation, is multi¬plying a year's worth of after-tax earnings by an industry average multiple based on the P/E ratio of public companies in the industry. This method must be used with care. To say that a young private company with earnings of $250,000 in an industry