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← Series 79: Collection, Analysis & Evaluation of Data
Series 79 practice questionhardFinancial Statement Analysis

An investment banker is analyzing two potential acquisition targets. Company A has an EBITDA margin of 25% on $400 million in revenue but negative free cash flow due to heavy capital expenditures. Company B has an EBITDA margin of 18% on $600 million in revenue with strong free cash flow conversion of 85%. Which metric should the banker emphasize when advising the acquirer?

  1. AFree cash flow conversion, as it reflects the target's ability to generate actual cash after required reinvestment✓ Correct answer
  2. BRevenue, as Company B's larger top line indicates a better acquisition
  3. CEBITDA margin alone, as it best reflects operating efficiency
  4. DEBITDA in absolute dollars, as it is the standard M&A valuation metric
Explanation

Why A — Free cash flow conversion, as it reflects the target's ability to generate actual cash after required reinvestment

While EBITDA is a common valuation metric, free cash flow conversion is critical because it reveals how much of the earnings translate into actual cash available to the acquirer after necessary capital expenditures. Company A's negative free cash flow despite high EBITDA margins suggests unsustainable capital intensity. An acquirer should focus on the quality and sustainability of cash flows, not just headline profitability metrics, when evaluating targets.

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