Firm Valuation with Bankruptcy Risk

Jennergren L. Peter ()
Additional contact information
Jennergren L. Peter: Department of Accounting, Stockholm School of Economics, Stockholm, SE 11383, Sweden

Journal of Business Valuation and Economic Loss Analysis, 2013, vol. 8, issue 1, 91-131

Abstract: Traditional firm valuation discounts forecasted cash consequences that are understood as expected values under some scenario. It is not clear how, and to what extent, uncertainty is incorporated in the valuation. This article constructs a new valuation model where uncertainty, in particular bankruptcy risk, is explicitly included. Bankruptcy denotes a failure situation where a company ceases to operate and its assets are liquidated. At the end of each year, there is a jump to one of three possible states of the world at the end of the following year. A state is a combination of sales revenue for the firm being valued and return on the market index. The third state implies bankruptcy for the firm. The new model includes both the non-steady-state explicit forecast period and the steady-state post-horizon period and derives consistent values for the unlevered firm, the debt, the tax shields, the equity, and the levered firm. All discount rates, and the promised debt interest rate, are derived from certain basic parameters, using the CAPM. The model structure, in particular the manner in which sales revenue serves as driving variable, implies that one needs to perform only one discounting operation for each year, like in Fama (Journal of Financial Economics 5:3–24, 1977). A small annual bankruptcy probability is seen to lead to a noticeable value decrease. There is also a discussion of how to combine traditional firm valuation with inputs from the new valuation model, so as to take bankruptcy risk into account.

Keywords: valuation; bankruptcy; free cash flow; discounting (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://doi.org/10.1515/jbvela-2013-0009 (text/html)
For access to full text, subscription to the journal or payment for the individual article is required.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bpj:jbvela:v:8:y:2013:i:1:p:41:n:6

Ordering information: This journal article can be ordered from
https://www.degruyter.com/journal/key/jbvela/html

DOI: 10.1515/jbvela-2013-0009

Access Statistics for this article

Journal of Business Valuation and Economic Loss Analysis is currently edited by Bradley T. Ewing and James J. Hoffman

More articles in Journal of Business Valuation and Economic Loss Analysis from De Gruyter
Bibliographic data for series maintained by Peter Golla ().