Scribd
Upload
28 views

Business Valuation Amendment Class

XYZ Pharmaceuticals is a distressed pharmaceutical company with declining revenue, high debt, and financial difficulties. To value the company's equity, the analyst uses a DCF valuation approach combined with a probability-weighted distress sale method. The analyst calculates the going concern value using forecasts for revenue, margins, reinvestment, and debt levels over 5 years. A distress sale value is estimated as 20% of invested capital. The equity value is the probability-weighted sum of the going concern and distress sale values. The analyst compares the per-share value to the current market price to advise the client.

Uploaded by

sairad1999
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
28 views

Business Valuation Amendment Class

XYZ Pharmaceuticals is a distressed pharmaceutical company with declining revenue, high debt, and financial difficulties. To value the company's equity, the analyst uses a DCF valuation approach combined with a probability-weighted distress sale method. The analyst calculates the going concern value using forecasts for revenue, margins, reinvestment, and debt levels over 5 years. A distress sale value is estimated as 20% of invested capital. The equity value is the probability-weighted sum of the going concern and distress sale values. The analyst compares the per-share value to the current market price to advise the client.

Uploaded by

sairad1999
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 3

Business Valuation Advanced Financial Management

Case Study: XYZ Pharmaceuticals - Distressed Firm


XYZ Pharmaceuticals is a distressed pharmaceutical company. The firm has been facing financial
difficulties due to multiple factors, including intense competition, regulatory challenges, and a
decline in market share. XYZ Pharmaceuticals has a high debt burden resulting from an unsuccessful
product launch and increasing research and development costs.

The firms latest financial statements are shown in Exhibit 1 and Exhibit 2 below:

Exhibit 1: Income Statement for the year just ended (Rs. in Crores)
Revenue 12000
EBIT (5%) 600
Int expense (10%) 700
PBT -100
Tax (@25%) 0
PAT -100

Exhibit 2: Balance Sheet at T=0 (Rs. in Crores)


Uses of fund
Fixed assets 10000
Current assets 2000
Less: Current liability 2500
Net Current Assets -500
Invested capital 9500
Source of fund
10% Long term debt 7000
Equity share capital(Rs. 10 Face Value) 3000
P&L A/c Debit Balance -500
Net worth 2500
Invested capital 9500
Other relevant information is given in Exhibit 3
Exhibit 3: Other Information(Rs. in Crores)
Market value of equity 2400
Market value of debt 5000
Tax rate 25%
Rf 6%
Market Risk Premium 5%
Debt Rating B

1 Sanjay Saraf Educational Institute


Business Valuation Advanced Financial Management

Based on bond ratings, Exhibit 4 shows the cumulative probability of distress as well as the default
risk premium over and above Rf over a 5 years period.
Exhibit 4

Rating Cumulative probability of distress (5 years) Default risk premium


AAA 0.03% 1
AA 0.18% 2
A 0.20% 3
BBB 2.50% 4
BB 9.27% 6
B 24.04% 7
CCC 39.15% 10
CC 48.22% 14
C 69.65% 20
You are a research analyst and specialized in the valuation of distressed companies. A client of
yours is contemplating buying the stock of the company as it has falling by more than 50% in the
last two weeks. Hence he has approached you for advise. You recently read Aswath Damodaran’s
famous book “Dark side of valuation” and decided to use the method of “DCF Valuation + Distress
Value”.
Value of equity = Going concern value (1-Probability of distress) + Distress sale value of equity
(Probability of distress)

For the purpose of estimated going concern value, use the following-

 Take a 5 year horizon


 Revenue is expected to fall by 5% p.a. for the next 2 years, stay flat for the 3rd year, grow by 3%
for the 4th year and then stabilize at 7% p.a. from the 5th years onward forever.
 Operating margin will fall to 3% for the 1st 2 years, 4% for the 3rd year, 5% for the 4th year and
6% from the 5th year onwards forever.
 Tax rate 25%
 Re-investment rate as a percentage of NOPAT would be -10% for year 1, -5% for year 2, flat year
3, 2% year 4 and 4% year 5 onwards forever
 Debt equity ratio (Market value based) is forecasted to be 2 for year 1(rating B), 1.5 year
2(rating BB), 1.2 year 3(rating BBB), 1.1 year 4 (rating BBB) and stabilize at 1(rating A) form the
5th year onwards.

2 Sanjay Saraf Educational Institute


Business Valuation Advanced Financial Management

 There are three comparable firms to XYZ Pharmaceuticals which are declining but not under
distress-
Firms Beta D/E
A 1.6 1.5
B 1.9 2
C 0.9 0.2
Unlevered beta may be taken as an average of the above
 Beyond year 5, FCFF will grow at 7% p.a. forever

For the purpose of distress sale value, we can take that to be 20% of invested capital.

Calculate the per share value of equity, compare that with the existing market price and advise.

3 Sanjay Saraf Educational Institute

You might also like