Question

Discounted cashflow valuations are usually based upon the assumption that the firm will survive as a going concern. If you are valuing a young firm or a distressed firm where there is a significant likelihood that the firm will not make it as a going concern, how do you reflect that in your valuation?

Answer 1

Discounted Cash Flow valuation is based on projections of free cash flow of a the company for some forecasting period and terminal value calculation after that forecasting period, then discounting it to the present value by using appropriate discount rate. The stock price is calculated by dividing the value of equity by number of shares outstanding. If we are valuing a young firm or a distressed firm where there is a significant likelihood that the firm will not make it as a going concern then we will use modified discounted cash flow valuation.

Modified discounted cash flow valuation can be done in following manner –

• Based on adjusted expected cash flows so that the effect of distressed situation can be incorporated and appropriate value of the firm can be calculated
• Higher discount rate due to increased riskiness of the firm. Higher discount rate will discount the expected cash flows more severely so that the effect of distressed situation will be incorporated in valuation of firm.