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more similar the indication of value is to the basis of the subject interest, the more reliable it is (all other
things being equal).

The following discusses some other factors that should be assessed when synthesizing each general ap-
proach.

Income Approach

When the premise of the valuation is going concern, cash flow and earnings-based metrics are normally
afforded greater weight by valuation analysts. However, this can vary depending on the rigor with which
cash flow or earnings estimates are developed. A company’s earnings are ultimately the source of all
value, reflected either in dividends paid or in retained earnings, which are realized upon sale.

Based on the nature of the business and the metrics that affect cash flows, it is possible to project availa-
ble cash flows with a certain degree of confidence. However, the projections should always be evaluated
in light of the purpose of the analysis. The stability and consistency of historical revenue and expense
results should also be evaluated when assessing management projections.

Circumstances that are frequently encountered when a company is in financial distress can reduce the re-
liability of the income approach. Specifically, earnings can be difficult to estimate because the compa-
ny’s historical results are not a reliable predictor of future results. The company may be planning to re-
structure operations, which can make earnings difficult to estimate. Historical financial statements may
not be available or may be unreliable. It is not uncommon for employees with knowledge of operations
and financial results to have quit or been laid off, making it more difficult to prepare reliable earnings
estimates. A lack of confidence in the company’s historical and projected earnings can be a reason to
under-weight the income approach relative to a more reliable approach if one is available.

Alternatively, the income approach may be the most appropriate approach for a company in financial
distress because it can be tailored to the specific circumstances of the company. The operations and
earnings of a company in financial distress are rarely in a steady state. The cash flows used in the in-
come approach can take into account specific events such as asset sales, operational changes, price
changes, cost reductions, and many other factors, which make it well suited for companies going
through a restructuring.

In the case of a company in Chapter 11, the plan of reorganization will include financial projections for
the company after it emerges from bankruptcy. The financial projections in the plan of reorganization
will likely have been vetted through the bankruptcy process and should reflect the best estimate of the
company’s cash flows at the time. Although these projections can still be highly uncertain, they must be
used when preparing an income approach to determine the restructuring value of the company upon
emergence. An income approach based on the projections in the plan of reorganization is typically given
significant weight when used to estimate the restructuring value of the company upon emergence.

The risk and uncertainty regarding future operations and earnings can be accounted for in the discount
rate. The operational risks faced by a company in financial distress can be included in the company-
specific risk premium, which is difficult to measure. Company-specific risk estimates typically involve a
significant amount of professional judgment. If the level of subjectivity inherent in the discount rate is
high enough to affect the reliability of the income approach, then less weight should be placed on the
approach relative to more reliable approaches.

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