cashflowsforthepossibilityofdistress.Notonlydoweneed
toestimatetheprobabilityofdistresseachyear,wehaveto
keeptrackofthecumulativeprobabilityofdistressaswell.
Thisisbecauseafirmthatbecomesdistressedinyear 3 loses
itscashflowsnotjustinthatyearbutalsoinallsubsequent
years.
5.Weassumethatevenindistress,thefirmwillbeableto
receive thepresent value of expected cash flows from its
assetsasproceedsfromtheliquidationsale.Theproblemwith
distress,fromaDCFstandpoint,isnotthatthefirmceasesto
existbutthatallcashflowsbeyondthatpointintimearelost.
Thus, a firm with great products and potentially a huge
marketmayneverseethispromiseconvertedintocashflows
becauseitgoesbankruptearlyinitslife.Ifweassumethat
thisfirmcansellitselftothehighestbidderforadistresssale
valuethatisequaltothepresentvalueofexpectedfuturecash
flows, however, distress does not have to be considered
explicitly.Thisisadauntingassumptionbecausewearenot
onlyassumingthatafirmindistresshasthebargainingpower
todemand fairmarket valueforits assets,butwearealso
assuming that itcan dothis not only with assets in place
(investments it has already made and products that it has
produced)butwithgrowthassets(productsthatitmighthave
been able to produce in the future).
In summary, the failure to explicitly consider distress in
discounted cash flow valuation will not have a material
impact on value if any the following three conditions hold:
1.Thereisnopossibilityofbankruptcy,eitherbecauseofthe
firm’s size and standing or because of a government
guarantee.