- Easy accessto capital markets allows firms with good
investments to raise debt or equity capital to sustain
themselvesthroughbadtimes,thusensuringthatthesefirms
will never be forced into a distress sale.
3.Weuseexpectedcashflowsthatincorporatethelikelihood
ofdistressandadiscountratethatisadjustedforthehigher
riskassociatedwithdistress.Inaddition,weassumethatthe
firmwillreceiveliquidationsaleproceedsthatareequalto
thepresentvalueofexpectedfuturecash flowsas agoing
concern in the event of a distress sale.
Ifthese conditionsdonot hold, and itiseasy to makean
argumentthattheywillnotformanyfirmsatsomepointsin
time, discounted cash flow valuations will overstate firm
value.
Adapting Discounted Cash Flow Valuation in Distress
Situations
Whenwillthefailuretoconsiderdistressindiscountedcash
flow valuation have a material impact on value? If the
likelihoodofdistressishigh,accesstocapitalisconstrained
(byinternalorexternalfactors),anddistresssaleproceedsare
significantly lower than going concern values, discounted
cashflowvaluationswilloverstatefirmandequityvaluefor
distressedfirms,evenifthecashflowsandthediscountrates
arecorrectlyestimated.Inthis section,weconsiderseveral
waysofincorporatingtheeffectsofdistressintotheestimated
value.
Simulations