Module II· Special Situations ValuationIntermediate
Question
What is a stressed DCF, and how does it differ from a standard DCF?
Answer
Stressed DCF
a DCF variant that models distress risk explicitly. Three main adjustments:
- Probabilistic cash flows: multiple scenarios (recovery 60%, stagnation 30%, liquidation 10%), a probability-weighted outcome.
- Higher discount rate: standard WACC + a distress premium (typically 200–500 bps), reflecting the elevated risk and a liquidity premium for investors.
- Shorter forecast: 3–5 years explicit, often without a classic terminal value (instead a run-off or a recovery-back-to-going-concern trajectory).
Alternatives to the stressed DCF
- APV (adjusted present value): unlevered DCF + tax shield + distress costs separately.
- Real-options valuation: equity as a call option on asset value.
Use case
distressed M&A, DIP financing, bankruptcy-exit valuations.
Deep diveShow more details
Pitch tip
'For distressed targets a stressed DCF is a scaffold — the primary valuation often comes from trading comps in a 'restructured recovery state'.'