Key Methods of Business Valuation for Distressed Firms

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Key Methods of Business Valuation for Distressed Firms

CFO Tech Outlook | Friday, April 29, 2022

A distressed firm is having difficulty repaying its debts and other financial responsibilities.

Fremont, CA: Valuation of any firm may be a difficult task. But when it comes to the company value of a troubled firm, the task becomes much more difficult and critical. A distressed firm is having difficulty repaying its debts and other financial responsibilities. This might be due to illiquid assets, large fixed expenses, and revenue volatility due to economic downturns. As the cost of borrowing rises, this might lead to operational imbalance.

Let's see some of the key business valuation techniques for distressed firms below.

Valuation of Discounted Cash Flows

The sole difference between the modified and classic discounted cash flow techniques is that the cash flows are adjusted for the risk of default in this method. The following is the formula for calculating projected cash flow:

SUM of Expected Cash Flows (Estimated cash flow for each scenario*Scenario probability)

It should be noted that perhaps the modification for distress is cumulative and will have a major influence on future free cash flow.

Distress Value plus Discounted Cash Flow Valuation

The following formula helps calculate this method:

DCF value of equity on an ongoing basis (1 – the probability of distress) + Distress sale value of equity (Probability of distress)

However, the following considerations should be in mind during the business appraisal process:

The business valuation should always be performed using the going concern assumption, which includes a traditional valuation.

The likelihood of distress must get estimated.

Calculate the equity's distressed selling value.

Valuation Relative

This strategy is further subdivided into two techniques. They are as follows:

The first approach compares the troubled company's valuation to comparable distressed firms or compares the valuation with stable enterprises while accounting for the distress.

The difficulty with the first strategy is that it may not always be possible to find comparable struggling firms. Therefore, in the second method, the troubled firm is considered healthy in the future. As a result, an estimate is created based on its future worth, which is then discounted again to get at a going-concern value, to which the risk of distress plus distress sale revenues is added to arrive at the best value.

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