The Cost of Distress: Survival, Truncation Risk and Valuation

50 Pages Posted: 2 Mar 2006

See all articles by Aswath Damodaran

Aswath Damodaran

New York University - Stern School of Business

Date Written: January 2006

Abstract

Traditional valuation techniques - both DCF and relative - short change the effects of financial distress on value. In most valuations, we ignore distress entirely and make implicit assumptions that are often unrealistic about the consequences of a firm being unable to meet its financial obligations. Even those valuations that purport to consider the effect of distress do so incompletely. In this paper, we begin by considering how distress is dealt with in traditional discounted cash flow models, and when these models value distress correctly. We then look at ways in which we can incorporate the effects of distress into value in discounted cashflow models. We conclude by looking at the effect of distress on relative valuations, and ways of incorporating its effect into relative value.

Keywords: distress, value, adjusted present value, survival

JEL Classification: G12, G33

Suggested Citation

Damodaran, Aswath, The Cost of Distress: Survival, Truncation Risk and Valuation (January 2006). Available at SSRN: https://ssrn.com/abstract=887129 or http://dx.doi.org/10.2139/ssrn.887129

Aswath Damodaran (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0340 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.damodaran.com

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