Valuing Declining and Distressed Companies

Abstract

The most difficult companies to value are at either end of the life cycle, with young growth companies and declining companies posing the biggest challenges. In this paper, we focus on companies that are at the tail end of their life cycles and examine how best to value companies with flat and declining revenues and stagnant or dropping profit margins. Since many of these companies also have significant debt burdens, we also evaluate ways to incorporate the possibility of distress and default into value. We argue that conventional discounted cash flow valuations, premised on firms being going concerns, will tend to overstate the value of distressed companies, and suggest ways in which we can correct for the bias.