Module II· WACC & Capital StructureIntermediate
Question
How do you calculate WACC for a distressed company?
Answer
Mechanics
In distress (bond YTM >15%, equity value collapsing), standard WACC is unreliable. Problems:
- The cost of debt is effectively a distressed equity return.
- The market value of equity trends toward zero — the weights become absurd.
- The tax shield doesn't apply fully when there is no taxable income. Solutions: (1) adjusted present value (APV): standalone valuation plus a separate tax-shield value, less distress costs. (2) Restructuring valuation: value under the new post-restructuring capital structure. (3) Liquidation floor: run-off or asset-sale value.
Deep diveShow more details
Pitch tip
On distressed mandates, replace DCF-WACC with APV — a clean separation of operating and financing value.