TMA Valuation in Distressed Situations 1 — Questions and Answers
Question 1: What is the most common valuation methodology used for a distressed company in Chapter 11?
- Dividend discount model
- Discounted cash flow (DCF) and comparable company/transaction analysis (Correct answer)
- Book value of assets only
- Price-to-earnings ratio analysis
Correct answer: Discounted cash flow (DCF) and comparable company/transaction analysis
DCF analysis combined with comparable company and precedent transaction analysis forms the standard valuation toolkit in Chapter 11, used to establish enterprise value for plan confirmation.
Question 2: Why is discount rate selection particularly challenging in distressing company valuations?
- Distressed companies have no cost of equity
- The risk profile of a distressed company is unusual, making WACC estimation unreliable (Correct answer)
- Regulators set the discount rate for bankruptcies
- DCF is not used in bankruptcy valuations
Correct answer: The risk profile of a distressed company is unusual, making WACC estimation unreliable
The capital structure of a distressed company is in flux and its risk profile differs markedly from healthy peers, making the weighted average cost of capital (WACC) difficult to estimate reliably.
Question 3: What is 'liquidation value' and when is it most relevant?
- The company's IPO valuation
- The estimated proceeds from selling all assets quickly, often under forced conditions (Correct answer)
- The book value of assets per the balance sheet
- The value assuming maximum operational efficiency
Correct answer: The estimated proceeds from selling all assets quickly, often under forced conditions
Liquidation value estimates what creditors would receive if assets were sold quickly — often at a discount — and is the floor used in the 'best interests of creditors' test in bankruptcy.
Question 4: What does 'enterprise value to EBITDA' multiple reflect in a distressed valuation?
- The ratio of debt to earnings
- How the market values a company's operating earnings, used to benchmark valuations against peers (Correct answer)
- The book value multiple of the company
- The premium paid over liquidation value
Correct answer: How the market values a company's operating earnings, used to benchmark valuations against peers
The EV/EBITDA multiple reflects what investors pay for each dollar of operating earnings; in distressed valuations it is applied to normalized EBITDA to estimate sustainable enterprise value.
Question 5: What is 'normalized EBITDA' in the context of a distressed company?
- EBITDA before interest payments
- EBITDA adjusted to remove one-time items and reflect sustainable run-rate earnings (Correct answer)
- EBITDA calculated according to court-approved accounting methods
- EBITDA divided by the number of creditor classes
Correct answer: EBITDA adjusted to remove one-time items and reflect sustainable run-rate earnings
Normalized EBITDA removes non-recurring charges, one-time items, and management adjustments to reflect what the business can sustainably earn under normal conditions.
Question 6: What is 'reorganization value' in a Chapter 11 plan?
- The liquidation value of the company's assets
- The going concern enterprise value of the reorganized company used to allocate value among stakeholders (Correct answer)
- The total amount of claims filed in the bankruptcy
- The DIP financing amount approved by the court
Correct answer: The going concern enterprise value of the reorganized company used to allocate value among stakeholders
Reorganization value is the total enterprise value of the company as a going concern after emerging from bankruptcy, used to determine how much each creditor class recovers.
TMA Valuation in Distressed Situations 1
What is the most common valuation methodology used for a distressed company in Chapter 11?