Distress Valuation: How to Value a Company in Crisis

Learn 4 powerful methods + Real-World Tools to assess distressed firms.

Why Distress Valuation?

📉 Traditional DCF assumes the company will survive and grow.

🚫 But in reality, some businesses face severe financial stress — risking default, restructuring, or liquidation.

💡That's where Distress Valuation comes in — it captures the true worth of a company when survival is uncertain.

🎯 Use these techniques to value companies beyond just hope — grounded in probability, recovery, and risk.

Method 1-

DCF + Distress Sale Value

Combine two scenarios:

✅ Revival (going concern) → Use DCF Value

❌ Liquidation (distress sale)→ Use % of Book or DCF Value

Formula: DCF × (1 - Probability of Distress) + Distress Sale Value × Probability of Distress

Example: DCF value is at 5000cr, distress value is 1200. The probability of success is 40% and the probability of distress is 60%.

Method 2-

Modified Cash Flow Method

Adjust each projected cash flow:

Cash Flow × (1 - Distress Probability)

More granular and situation-based than Method 1.

Helps value operations during unstable years.

Method 3-

Relative Valuation with Distress Discount

• Use EBITDA or Revenue multiples from industry
• Avoid P/E (earnings may be negative)

Adjust multiple based on:

• Bond ratings
• Industry distress history
• Altman Z-Score

Formula:

Distress-adjusted value = Relative value based upon healthy firms (1 - Probability of distress) + Distress sale proceeds (Probability of distress)

Method 4-

Adjusted Present Value (APV)

Formula:

APV = Unlevered Firm Value + Tax Shield – Bankruptcy Cost

How it works:

• Value firm as if no debt (use FCFF @ unlevered cost of equity)
• Add PV of tax savings (usually ~30% of debt)
• Subtract Bankruptcy Cost= (Unlevered Value – Distress Value) × Probability of Distress

When to Use:

✅ Firm in distress

✅ Changing capital structure

✅ Need to separate financing & business risk

How to Estimate Probability of Distress?

Use tools like:

✅ Altman Z-Score

✅ Bond Ratings

✅ Distress Sale Benchmarks

Z-Score Formula:

Z = X1 + X2 + X3 + X4 + X5

• X1= Working Capital / Total Assets X2= Retained Earnings / Total Assets X3= EBIT / Total Assets
• X4= Market Value of Equity / Book Value of Total Debt
• X5= Sales / Total Assets

Z < 1.81 =Distressed – High bankruptcy risk

Z > 2.99 = Healthy– Low risk of bankruptcy

1.81 – 2.99= Grey Zone – Medium risk

Practical Insights on Distress Valuation

Distress Sale Value ≠ Full Book Value

Often just 20–50% of book (e.g., Telecom firms)

DCF isn't enough

Account for scenarios where company shrinks or sells key assets

Estimate Distress Probability

Use bond pricing, credit spreads, or Altman Z- Score