operatingmargins,thetwomostcriticalvariablesdetermining
equityvaluearethedurationofthedebtandthevariancein
firmvalue.Anyactionthatincreasesthedebtdurationwill
haveapositiveeffectonequityvalue,and anydecreasein
debtdurationwillnegativelyaffectequityvalue.Forinstance,
whentheFrenchgovernmentputpressureonthebankerswho
hadlentmoneytoEurotunneltoeaserestrictionsandallow
the firm more time to repay its debt, equity investors
benefitedastheiroptionsbecamemorelong-term.Similarly,
anactionthatincreasesthevolatilityofexpectedfirmvalue
will increase the value of the option.
CONCLUSION
Distressedfirms (i.e.,firmswith negativeearningsthatare
exposed to substantial likelihood of failure) present a
challenge to analysts valuing them because so much of
conventionalvaluationisbuiltonthepresumptionthatfirms
aregoingconcerns.Inthischapter,wehaveexaminedhow
both discounted cash flow valuationand relative valuation
dealanddonotdealwithdistress.Withdiscountedcashflow
valuation, we suggested four ways in which we can
incorporatedistressintovalue—simulationsthatallowforthe
possibilitythat a firmwillhaveto be liquidated,modified
discountedcashflowmodelswheretheexpectedcashflows
and discountrates areadjusted to reflectthelikelihood of
default,separatevaluationsofthefirmasagoingconcernand
indistress,andadjustedpresentvaluemodels.Withrelative
valuation,wecanadjustthemultiplesfordistressoruseother
distressed firms as comparable firms.
Inthelastpartofthechapter,weexaminetwoissuesthatmay
comeupatdistressedfirmswhengoingfromfirmvalueto