On the Valuation of distressed firms: A conceptual framework and case application

Abstract

This research study introduces a valuation model that adapts the traditional valuation models to the speci c circumstances of rms that are in the de- clining stage of the maturity lifecycle and also nd themselves in nancial distress. The model is based on the traditional valuation methods and at- tempts to correct for the limitations by adapting the methods to account for the special characteristics of rms in this particular situation. The analysis shows that one of the main factor distorting the analysis of the traditional valuations methods is the incorrect treatment of the risk of default. In order to consider this risk, this study proposes a model that estimates the risk of default, using a probability of default estimation model based the Black and Scholes theorem, and incorporates it in the traditional valuation method. The adapted model is then applied to the case of the Eastman Kodak com- pany in the years before its bankruptcy. It is found that the model yields accurate results that are in range with the market valuation but that it's also highly sensitive to the input parameters.