Step5:Theexpectedcashflowsareestimatedbasedonthe
outcomesdrawninstep4.Ifthefirmmeetsthecriteriafora
going concern,definedbeforethesimulation,we willthen
discountthecashflowstoarriveataconventionalestimateof
discountedcashflowvalue.Ifitfailstomeetthecriteria,we
will value it as a distressed firm.
Step6:Steps 4 and 5 arerepeateduntilasufficientnumberof
simulations have been conducted. In general, the more
complexthedistribution(intermsofthenumberofvaluesthe
variablecantakeonandthenumberofparametersneededto
define the distribution) and the greater the number of
variables, the larger this number will be.
Step7:Eachsimulationwillgenerateavalue,goingconcern
ordistressedasthecasemaybe,forthefirm.Theaverage
acrossallsimulatedvalueswillbethevalueofthefirm.We
shouldalsobeabletoassesstheprobabilityofdefaultfrom
the simulation and the effect of distress on value.
The primary limitation of simulation analysis is the
informationthatisrequiredforittowork.Inpractice,itis
difficultto choose both therightdistribution to describea
variableandtheparametersofthatdistribution.Whenthese
choicesaremadecarelesslyorrandomly,theoutputfromthe
simulation may look impressive but actually conveys no
valuable information.
Modified Discounted Cash Flow Valuation
Wecanadaptdiscountedcashflowvaluationtoreflectsome
ormost oftheeffectsofdistress onvalue.To dothis, we